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Overseas inflows set to fall as inflation spurts

Overseas inflows set to fall as inflation spurts

New Delhi: India could see foreign capital inflows slowing as inflation soars and macroeconomic risks increase, experts say.

Bimal Jalan, former Reserve Bank of India (RBI) governor, says that while there may be limited impact in the short term, “capital inflows in the future may be a problem" and that “one has to wait for a month before things get clearer". Similarly, the chief economist of a leading bank, who did not wish to be identified, says, “It is not yet a macroeconomic crisis, but in the present scenario, the tipping point is not a particular level of inflation, but the time for which it stays at a high level like 11%."

(GROWING, BUT AT A SLOWER PACE) It would be a double whammy for Indian firms. Not only will they have to absorb higher costs due to the inevitable hike in domestic interest rates, they will also have to contend with the problem of diminishing sources of capital.

The sharp rise in the country’s inflation rate has led to negative real interest rates, or interest rates corrected for inflation. The ensuing political instability due to differences between the ruling United Progressive Alliance and its Left allies will only add to risk perceptions surrounding India and, consequently, Indian companies, thereby raising the coupon or interest rate at which these firms can raise money outside the country.

The wholesale price-based inflation rate hit a 13-year high of 11.05% for the week to 7 June, up from 8.75% in the previous week, after the impact of a fuel price hike kicked in.

According to the bank economist, if inflation continues to hover at “such high levels for anywhere between three and six months", it may result in economic growth slowing. The first indications of a slowdown in foreign capital inflows will be captured in the net foreign exchange assets of the country.

So far, to prevent the rupee’s rise, RBI has been buying dollars and adding to currency reserves that are estimated at $310.6 billion (Rs13.36 trillion). According to the latest weekly RBI data, the country’s foreign exchange reserves—inventories of hard currencies and gold held by the country’s central bank—fell by $4.9 million for the week to 13 June, the largest fall in two years and?the?second?largest?fall?ever.

While both Jalan and the economist say they are surprised at the extent of the jump in inflation, which rose by 2.3 percentage points over the previous week, others such as Saumitra Chaudhuri, member of the Prime Minister’s economic advisory council, say “most sophisticated investors" would not have been surprised. “I think the capital inflows will continue, though at a subdued pace till perhaps September (or the halfway mark of the current fiscal) and then pick up again," he adds.

If capital flows do slow drastically, it could expose India to a new risk. The country has a trade deficit that will only widen if the dollar continues to depreciate against other currencies and oil prices remain firm. Together with transfer payments, such as remittances and software earnings, India’s current account deficit, now at $16 billion—or 2% of gross domestic product (GDP)—may? be a cause for worry.

The trade deficit, the excess of imports over exports, for the year to March was estimated at $80.4 billion, 35.5% higher than the deficit at $59.3 billion in the previous fiscal year. But Chaudhuri and Jalan say this is not a matter of concern as “it can be financed by the existing capital inflows". But the bank economist disagrees. “A current account deficit of 2-3% of GDP is manageable given a certain level of capital inflows, and flexibility to manage this will be lost as capital inflows start drying up," he said.

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