RBI fears inflow impact on emerging markets

Having revised short-term lending rates at regular intervals in the past few months, the Reserve Bank shares concerns of the IMF on the impact of capital flows and remains worried over continuing inflationary expectations.

Concerns raised by RBI Governor Y V Reddy in his interaction with industry and financial market representatives ahead of monetary policy review are similar to a warning sounded by the International Monetary Fund against the "volatility shock" in the emerging markets.

The inflation rate which averaged 5.3% in FY07 "may become 7%", Reddy said.

D S Rawat, secretary general, Assocham who was present in the meeting said the governor's biggest concern was inflationary expectations.

Reddy said India, being an important emerging market, has become a favoured destination for the capital flows from the developed world and "it is a big challenge for us".

The IMF echoed similar views in its Global Financial Stability Report. It warned investors against a "volatility shock".

"Although emerging market fundamentals continue to improve overall, rapid capital flows into some emerging market countries could pose challenges for financial stability," the IMF said.

The report argued that investors may not be giving sufficient weight to downside risks leaving markets vulnerable to the possibility of a shock. The risks are being amplified by the increased linkages across financial products and markets, it said.