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With the loose monetary policies being practiced by the rich western countries, and the return of global investors to emerging markets in droves for better yields, the debate on the free flow of capital across countries is once again heating up. Reports indicate that lured by better growth prospects and disheartened by the continuous low interest rates in rich countries, capital is rushing into countries like Brazil, Peru, South Africa, Turkey, India and China.
Normally, emerging markets welcome such capital inflows, for it helps finance their investment needs. This time around it is, however, causing much worry: the speed of such inflows and the fear that their reversal could also be equally fast is disturbing the policy makers in these countries. According to IMF’s estimates, the gross inflows into emerging economies have risen to 6% of their GDP, that too, just in a quarter of a time that it took for a similar rise before the crisis. Obviously such a gush of funds makes policy makers worry about its potential to create asset price bubbles, besides over-valued currencies. And appreciating currencies may in turn impact the growth prospects of their economy by making exports less competitive in the global market that is already suffering from shrinkage in demand.
This phenomenon has obviously made countries like Brazil and Peru impose measures to control such inflows: Brazil has imposed tax on portfolio inflows and Peru has fixed higher charges on bank papers meant for sale to non-residents. Imposition of such controls on capital flows by emerging economies has all along been resented. Countries resorting to such controls have traditionally been accused of manipulating to keep their currencies artificially undervalued, so that they could boost their exports, while at the same time discouraging imports. But surprisingly this time around, the IMF – the principle arbiter on such issues – has remained silent over these developments. Indeed, in one of its papers, the IMF suggested for capital controls whenever there is a sudden rush of inflows, while in another paper said to be a frame-work paper, again it preferred controls for persistent inflow of capital might result in asset price bubbles of dangerous proportion.
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So far so good; but when it comes to India, the situation becomes different. It was earlier reported that the global investors, who brought huge capital to participate in the IPOs from PSUs such as coal India Ltd have fled Indian markets in February taking away around $ 29 bn to capitalize on the reported rise in the valuations of assets in the western markets in tune with the global recovery that gained momentum. This has indeed caused concern for some in the Indian market; more so in the light of declining inflows under direct investment in the current year, for it will have adverse impact on current account deficit. The return of global investors with an investment of $1.5 bn in stocks and bonds in April has brought relief to market players – as also to policy makers, for the economy needs more of such inflows to fund the current account deficit, which is estimated at 3% of our GDP. And, with the kind of rise in crude prices being witnessed today and the ongoing civil unrest in West Asian countries that could further impact the oil prices, there is hardly any scope for India to rein in the widening deficit in the near term.
That aside, the import cover of reserves too is said to be falling: as against 16.5 months imports in February, 2009, today it stood at 9.5 months. Even NRI deposits are reported to be falling; nor did external commercial borrowings grow, that too, despite easing the policy guidelines. All this does not augur well for the much desired double digit growth rate.
It is time the RBI focused on the external sector more actively to ensure inward flow of foreign capital to meet current account financing while managing interest rates in such way that it would not hurt growth prospects. A walk on double-edged sword? After all, Central banking has never been that easy!
- GRK Murty
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