Watching the money flow in
Everybody agrees that there is danger in so-called 8220;hot money8221;, which is essentially short-term in nature. This 8212; constitutin...
Everybody agrees that there is danger in so-called “hot money”, which is essentially short-term in nature. This — constituting more than 9 billion of foreign investments in the Indian securities market — forms a major chunk of market capitalisation. Any buying and selling decision by this portfolio investment influences stock prices to a great extent. Foreign institutional investors FIIs also use their market presence as a lever to influence decision making in India, whether it is with regard to the securities transaction tax or the clarification on Press Note 18. After all, a capital market intermediary, regulator or, indeed, the government, is naturally jittery at the prospect of a rerun of the May 17, 2004 debacle, that had resulted in a fall of more than 800 points in the Sensex in a single day.
Earlier, when Indian stock markets were being opened to investment from FIIs, there was a proposal for some sort of a stabilising fund being established. Now encouraging the participation of retail investors in the market to counter the influence of FIIs is also being discussed. But these steps at this juncture have the danger of providing an exit route to FIIs at these levels, even though they had entered the market at very low levels.
We are then caught in a Catch-22 situation where the investments in the market by FIIs will lead to a rise in the Sensex, thereby benefitting the market, but will at the same time increase the risk of the market being in the control of these very players. They have so much control on volatility that measures of governmental control adversely effecting their interest cannot even be discussed. In the past, the RBI would tighten money supply, slow down loan demand and strangle inflation. But now with foreign funds flooding the country with liquidity, the efficacy of monetary measures is reduced.
The issues have been very clearly highlighted in a report on currency and finance by the RBI, in which some suggestions and remedies to deal with the problem have also been mooted. What is required is the building of a consensus. The report points out that since the magnitudes of FDI/FII inflows tend to be large, volatility has perhaps increased. The impact of such flows on the stock markets is discernible, but perhaps less evident at this juncture in corporate ownership and control. The possible issues that need to be considered if one were to achieve a better management of the non-debt components of capital flows are what is now outlined: One, a view needs to be taken on the quantity and quality of FII flows. Two, there is scope for enhancing the quality of flows through a review of policies relating to eligibility for registration of FIIs. A strict adherence to the ‘Know Your Investor’ principle, especially with regard to flows from tax havens, would enhance quality. Three, price-based measures such as taxes could be examined. It may be mentioned that countries across the world have begun making a case for a tax on foreign exchange transactions as a way to avoid currency rises and increase the national government’s economic autonomy. The objective of the tax is to discourage short-term speculation.
Four, FDI flows as currently defined, also include transfer of equity from residents to non-residents and a disaggregated analysis of FDI through several routes could enable a policy-intervention, as appropriate on quantities and quality. Five, reporting and monitoring arrangements could be considered for assessing the aggregate shares of residents and non-residents in large corporations and those in sensitive sectors in particular. Such monitoring could help timely policy responses on several fronts.
Finally, consistent with the principle of a hierarchy of capital flows, a view could be taken on the relative policy emphasis on sources and types of investment that need to be encouraged. For example, it is well recognised that giving better incentives to foreign investors over domestic investors results in an increased scope for “round-tripping” and inefficiencies. Similarly, if avenues for portfolio flows or equity-transfers from domestic to foreign investors are easily available, the flows under FDI defined in terms of adding to domestic production-capacities will tend to be smaller. Attention to these may simultaneously address institutional issues relating to corporate ownership, volatility issues relating to capital flows and financial markets and, above all, will ensure high-quality inflows of foreign savings as a healthy supplement to domestic savings, which is more important to our country at this stage of development.
The writer is a member of the BJP’s Central Economic Cell. The views expressed here are personal
Share
