A question that the extraordinary growth of 7.9% in the second quarter raises is whether this will lead to a surge in capital inflows that will bring with it its own set of policy problems. Will the capital flows lead to the rupee appreciating, money supply surging and expectations of inflation rising? Will it fuel inflation in asset prices? Will we have to sterilise this inflow or do we have the capacity to absorb these into the real economy? Should we introduce the Tobin tax like Brazil has done or more generally, should we discourage such inflows?
Policymakers have been posed these questions and the responses seemed to suggest in late November that imposition of such a tax is not in the cards. However, more recently, the responses seem a little more iffy, implying that it depends upon how much capital will actually come and what it will do to the economy. But, there is not much reason to be cautious on being categorical that there is no case for discouraging capital flows at this point in time.
According to estimates made by analysts at CMIE, India should be seeing net capital flows of the order of $36.5 billion in 2009-10. This would be four times the flows in 2008-09. But 2008-09 should be seen in two parts?before the crisis that emerged in the middle of the year and after the crisis. In the first half net capital inflows were of the order of $18.7 billion and then in the second half there was a net outflow of nearly $10 billion. Thus, the $36.5 billion expected in 2009-10 (of which less than $7 billion came in till June) are not extraordinarily high if you compare them to the pre-crisis level of flows. In fact, they are low when compared to the flows the year before. In 2007-08, net capital flows were of the order of $108 billion.
Of the $36.5 billion of capital flows expected in 2009-10, about $17 billion is expected to be used to finance the current account deficit. That leaves an ?excess? of about $30 billion. This capital inflow of $30 billion is unlikely to shake the rupee too much from its current level. The rupee has been remarkably stable at around Rs 47 to a dollar in recent months. It is also likely to remain around this level in the remaining months of the year.
Such a level of capital flow is unlikely to cause an inflation in asset prices as well.
Most of $36.5 billion of capital inflows come in the form of FDI and portfolio investments of FIIs. CMIE expects both these inflows to be of the order of $23 billion in 2009-10. The expectation is that foreign direct investments will maintain a steady flow with about $10 billion flowing in during the second half of the year. These are unlikely to rise too dramatically.
FDI inflows are mostly for investments in new capacities. Projects that attract large FDI progress slowly because most of these face problems in land acquisition and need regulatory clearances. It is unlikely that these problems will be resolved soon enough to cause a deluge in FDI. The other (smaller) component of FDI is acquisition of shares. In this case, the global companies are not in a position to accelerate their acquisitions compared to the pace before the crisis. In 2007-08 and 2008-09, FDI on account of acquisition of shares amounted to a mere $5.1 billion and $4.6 billion.
But what about the fluid and fickle FII investments? I would wager here that the current valuations of listed Indian companies do not leave much room for a significant increase in investments during the remaining months of the current fiscal. While a rapid recovery is clearly under way and the long-term India story looks brighter by the day, these bright spots have already been built into the price. FII investments will thus grow at a slower pace than it did in the first half of the year.
The price-earnings multiple of the 30 Sensex companies is at 22 times, that of Nifty50 companies is at 22.5 times and the over-2,000 companies of COSPI is at 22. We are not in euphoric times yet for valuations to go too far from such highs. Net FII investments in the Indian equity and debt markets have already shown signs of slowing down. Investments during November 2009 at Rs 6,011 crore were nearly half the average investments of Rs 11,978 crore per month in the first half of the year.
External commercial borrowings have been weak and are expected to remain so in the current year. While companies are seeking approvals from RBI, they are not actually raising the capital. If capital flows are unlikely to be too high, it does not make sense to even hint at the possibility of discouraging them. The current level of capital flows is incapable of causing hikes in the prices of commodities or assets. It makes more sense to let speculation on the policy stance rest and let capital flows come in.
The author heads Centre for Monitoring Indian Economy