Economists are warning that New Delhi may be underestimating the risks of excessive capital inflows, as huge foreign portfolio investment into India has helped push both the stock market and the rupee to pre-crisis levels.
Since January, India’s equity and bond markets have attracted a record $33.8bn in foreign funds on the back of the country’s robust economy, which grew 8.8 percent year-on-year in the second quarter. However, during the same period foreign direct investment – which tends to be more long-term than inflows into the stock market – dropped 35 percent, down to Rs637bn ($14.4bn) from Rs976bn.
Neil Beer | Photodisc | Getty Images
--------------------------------------------------------------------------------
“India’s dependence on foreign capital to grow its economy is a limiting factor,” said Ridham Desai, India equity strategist for Morgan Stanley. “What seems more critical to us is the mix of capital flows, which still are skewed toward capital market sources rather than foreign direct investment.”
A string of multibillion-dollar state-run IPOs, which will follow Coal India’s $3.5bn offering, is expected to attract further foreign capital, raising new concerns that the economy is overheating.
“Today there are several indicators that suggest that the economy is moving towards the overheating zone,” said Sonal Varma, chief India economist for Nomura. “We are not quite there but we should be vigilant.”
India’s emerging market peers, including Brazil, Indonesia, South Korea, Taiwan and Thailand, have taken some measures to curb foreign capital inflows and are acting to suppress resulting currency appreciations.
In the past month the Indian rupee [INR=X 44.25 -0.10 (-0.23%) ] has risen nearly 5 percent against the U.S. dollar. Last week the currency reached its highest level since the global financial crisis, hitting Rs44.11 against the dollar.
Yet despite the stronger rupee, India has decided to wait, as policymakers weigh up the pros and cons of allowing more “hot money” into Asia’s third-largest economy.
Some analysts believe that the government can absorb the extra liquidity given a widening current account deficit, which is estimated to be at about 3 percent of gross domestic product this fiscal year.
"The broader risk is that these bubbles are often fuelled by easier access to credit and if the bubbles burst it will have a negative impact on the entire banking sector."
Sonal Varma
Chief India Economist, Nomura
“At the moment the country needs the extra inflows to fund its deficit,” said Rashesh Shah, chairman of Edelweiss, a financial services group.
However, more cautious economists warn that the bounty of foreign cash could lead to unintended consequences, as a sharp reversal of capital inflows could negatively affect the country’s overall balance of payments.
“The government’s over-reliance on one-off sales of state-owned assets and the rising influx of foreign capital to fund its deficit is not healthy for the economy,” said A. Prasanna, chief economist at ICICI Securities. “These extra [foreign] funds could dry up from one moment to the other.”
The entry of short-term and volatile investments should be a prime concern for the government, according to Ms Varma.
“When you get too many inflows your asset classes start heating up and that leads to asset price bubbles,” she said. “The broader risk is that these bubbles are often fuelled by easier access to credit and if the bubbles burst it will have a negative impact on the entire banking sector.”
New Delhi said it was aware of the risks and had been playing down economists’ concerns. The country’s septuagenarian finance minister, Pranab Mukherjee, says that “there is nothing unusual about capital inflows … We have not reached the stage where the panic button needs to be pressed.”
No comments:
Post a Comment