Needed: more capital inflows

Needed: more capital inflows
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First Published: Fri, Oct 17 2008. 12 37 AM IST

Illustration: Jayachandran / Mint
Illustration: Jayachandran / Mint
Updated: Fri, Oct 17 2008. 12 37 AM IST
Both the Reserve Bank of India and the Union government have followed in the footsteps of their peers in the US and Europe, with massive injections of liquidity into the money market and the possibility of capital support for banks.
These moves have gained attention because they fit into the global pattern. But they are likely to address only the immediate credit squeeze and the troubles that banks could have in expanding a couple of years down the line. They do not tackle the real reasons why the Indian financial system is gasping for cash.
Illustration: Jayachandran / Mint
The financial crunch in the US and Europe is because banks are not lending to each other. They are frozen in fear. Our credit squeeze is not because of the fear that the bank you lend to today may not be around tomorrow to repay the money. The Indian money market is short of funds for a very different reason.
The recent battle to defend the rupee has sucked out huge liquidity from the system as the central bank sells dollars and buys rupees from foreign investors who are fleeing the stock market. It is best right now to assume that foreign money will continue to be pulled out of Indian shares. The challenge then will be to identify other forms of global capital that can be attracted.
These are tough times — and the real battle is to get in enough capital to fund the needs of a growing economy. Otherwise, it could be a hard choice between a free fall in the rupee or higher short-term interest rates.
That is why the other set of policy changes announced in recent days do deserve more attention. It is definitely a good idea to double the amount of money that foreign investors can put into the corporate bond market; a similar suggestion had been made in these columns on Monday.
There is reason to be more circumspect about two other moves — making it easier for foreign investors to buy shares in India through offshore participatory notes and increasing the effective interest rates on deposits from non-resident Indians. These may make sense right now, but there is a longer-term worry that much of the money that could flow in through these channels would be of a volatile nature.
Yet, these are welcome first steps. There are other options worth pursuing, such as a few big-bang privatizations or a government bond privately placed with a sovereign wealth fund. Such policies will matter more in the long run than temporary liquidity injections into a cash-starved money market.
How can India attract more foreign capital? Write to us at views@livemint.com
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First Published: Fri, Oct 17 2008. 12 37 AM IST