In a section in its annual report for the year ended June 30, 2010, ‘Capital Flows – Managing Surges and Sudden Shocks’, the Reserve Bank of India (RBI) has stated that “costs could magnify for an economy during periods of both too little and too much capital”. It went on to say that “there is a possibility of return of another phase of surge in capital flows to India, in response to global search for yield in an environment of easy liquidity... and the prospects of relatively higher return on investment in India.”
As a regulator, RBI has naturally focused on the management of problems this could cause, like inflationary pressure, export competitiveness and asset price build-up.
The ability to attract global capital, even if only as a result of an economic accident, is tremendous good fortune. We should not only prepare to “manage it”, but also to channel it productively. We have an uncanny ability to “snatch defeat from the jaws of victory” in this regard and so let us look at the probable consequences with pragmatism and not optimism. There are four broad possibilities as I see it.
First is the impact on interest rates. The debt market is relatively immune to direct inflow of international capital. Though, allowing unrestricted foreign institutional investors’ (FII’s) participation in the secondary market debt could boot-strap it out of illiquidity. If external commercial borrowing becomes more easily obtainable, domestic credit off-take is likely to come down.
Second, FII inflows will once again push the stock market upwards and should initially favour bellwether and other index stocks. Over the time, it should benefit the entire market. On the downside, we may also see a significant increase in volatility (and the consequent cries for regulatory intervention). I can’t see a unidirectional upward movement and am sure that local investors will keep booking profits and re-entering at each stage. Our own lack of confidence in our market is an unfortunate fact.
A significant inflow of foreign currency would put pressure on the rupee. But dare I say that at this stage, with infrastructure creation and technology upgrade being the need of the hour, we should look away from the problems of the information technology (IT) and IT enabled services industry and focus on the big picture of sustainable economic growth.
For all you shopaholics and gurus of Indian retailing, this is good news. It will also increase the local purchasing power and will fuel the continued consumer boom and inflow of foreign goods.
That brings me to the one great opportunity that we must not lose, which indeed has been hinted at by RBI: The opportunity to allow fund-based ownership/promotion of physical infrastructural assets. I think this is the time for us to embrace the Australian model in a big way. Of course, the question remains, will we treat this as an opportunity or as a problem.
The author is MD & CEO, IDBI Asset Management
