Banking on capital inflows2 min read . Updated: 31 Jan 2010, 11:42 PM IST
Banking on capital inflows
Banking on capital inflows
RBI achieves its purpose of signalling it’s not behind the curve, while the prospect of higher growth drives funds to the country’s markets.
Also See In Recovery Mode (Graphic)
What matters for the markets is not local but global liquidity and the US Federal Reserve has just said that it sees “exceptionally low levels of the federal funds rate for an extended period". A combination of local growth and global liquidity is excellent for the market.
Nevertheless, there are caveats to that story. During the bottom of the last interest rate cycle in 2003-04, the reverse repo rate had come down to 4.5% and the repo rate to 6%. At present, the reverse repo is at 3.25% and the repo at 4.75%. That is comforting. What’s worrying, though, is that in October 2004, when policy rates began to rise, banks’ credit-deposit ratio was 58%. Today, it’s 71%. So where will the support for higher credit growth come from? And where will banks find the money to fund the government’s borrowing programme, which RBI expects to be larger than last year on a gross basis?
The critical factor will therefore be capital inflows, which RBI seems to be banking on—its assumption seems to be that stronger growth will attract more funds.
That confidence appears on shaky ground at the moment, with the return of risk aversion.
Data from fund tracker EPFR Global shows that, in the week to 27 January, Bric (Brazil, Russia, India, China) equity funds saw net redemptions for the fist time since early September.
But there are two encouraging signs. One, inflows into Chinese equity funds moved up after the Chinese authorities acted to prevent asset bubbles and overcapacity, which suggests that investors like responsible action by central banks and governments. And two, money continued to move out of the US money market funds, which suggests, as EPFR put it, that “the appetite for more risk and greater returns is far from dead".
The risks are that global liquidity is dwindling and with growth trending higher, as the International Monetary Fund has recently forecast, that means lower excess liquidity to bolster asset prices. Further, as this column has shown earlier, the “higher growth in India, therefore more money flows in" story has its limitations, simply because our share of global market capitalization is already higher than our share of gross domestic product.
All the more reason, therefore, for the government to attract funds by relaxing the rules for foreign direct investment and divesting stakes in its companies on a large scale.
Write to us at firstname.lastname@example.org
Graphic by Yogesh Kumar / Mint