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This is an archive article published on January 3, 2012
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Opinion Capital move

2012 begins with an invite to new investors. This policy focus should continue

indianexpress

MK VENU

January 3, 2012 03:36 AM IST First published on: Jan 3, 2012 at 03:36 AM IST

The UPA government has chosen the start of 2012 to announce an important policy reform — to allow individuals from abroad to directly invest in Indian companies through the stock market route. So far,only foreign institutional investors (FIIs) and other foreign entities registered with the stock market regulator,SEBI,were permitted to buy shares on Indian bourses. Allowing individual retail investors globally to directly buy Indian stocks is an important step for greatly expanding the base of foreign portfolio investors looking at India. It also marks a major liberalisation of the capital account.

Critics may argue that the timing of the decision is possibly motivated by the fact that India has received negative foreign institutional inflows during 2011-12,and consequently there is an urgent,even desperate,need to attract other classes of investors from abroad to shore up capital flows into the country. However,history suggests that big policy decisions come only when governments find themselves in somewhat difficult situations. Of course,the current situation certainly cannot be characterised as a crisis,like the one faced in 1991 when India had to pledge gold to borrow dollars from the IMF to meet its immediate needs. But it will not be an exaggeration to suggest that our external sector will remain somewhat vulnerable until the big banks in the crisis-ridden eurozone resume their normal lending activity. This year’s shrinkage in capital flows is largely due to the euro situation.

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So India needs to undertake new policy reforms to provide the much-needed cushion against possible risks emerging in the external sector. In a sense,the vulnerabilities in the external sector caused by the global events will remain a major policy focus for India in 2012. The decision to allow all individual investors from abroad to directly buy equities in the Indian market exemplifies the special attention the government is paying to the external sector. The rapid depreciation of the rupee — about 17 per cent since October — has been caused essentially by slowing capital inflows on various fronts.

India needs a minimum of $50-55 billion to meet its current account deficit of about 3 per cent of GDP. So far in 2011-12,foreign institutional inflows in the stock markets have been a negative of over $500 million. Overall,global FIIs have withdrawn a net amount of $40 billion from all emerging markets. So every emerging market this year has suffered big sell-offs by FIIs.

Since no dollar inflows have happened on the FII account,we necessarily have to depend on other capital flows such as foreign direct investment (FDI),NRI deposits and foreign borrowing by corporates to make up the $50-55 billion needed to meet the current account deficit. India has received close to $30 billion as FDI but there has also been investment outflow in the form of Indian corporates investing about $15 billion abroad. So there has been a net inflow of only about $15 billion as FDI. Foreign borrowings by Indian companies are somewhat constrained by the European banks putting their house in order. They are shrinking their balance sheets and are not lending so liberally. Even if they are,it is at much higher costs. This adds to the external sector risk in the short run. India raised the interest rate some time ago on NRE dollar deposits to make it attractive for NRIs to put deposits in Indian banks. Overall,India has been grappling with its external sector situation with a sense of urgency over the past three to four months.

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In this regard,another factor of crucial importance is that India has to repay a total external debt of $137 billion which is maturing within financial year 2011-12. Of this,borrowing by companies maturing for repayment is about $20 billion or Rs 1 lakh crore. There is concern about the capacity of many companies,especially in the infrastructure sectors,to be able to repay their debt by March 31 this year. Any default by an Indian company could tarnish the name of the country as well in the international market.

Given some of these vulnerabilities,the government needs to get proactive in 2012 about reforms which stabilise the external sector. Most importantly,the UPA needs to clearly communicate to the opposition parties about the reforms aimed at strengthening the external sector. Many wondered why the UPA had suddenly pulled out FDI in multi-brand retail as a frontline item for reform,especially since it was on the back-burner for a long time due to political resistance.

Prime Minister Manmohan Singh wanted FDI in multi-brand retail partly to send a positive signal for the external sector. In a globalised world,such signalling has to be resorted to in order to effect a positive change in the investment climate. It is not that FDI would have poured in overnight in the retail sector. But there would certainly have been a positive impact on the external sector as well as on the rupee’s stability. This is in the national interest and the opposition needs to be clearly sensitised to this. For instance,it does not behove a former finance minister,known for his liberal policies under the NDA regime,to now say he does not believe that reforms are about attracting more foreign investment.

The larger issue is,the political class must decide whether it wants to be paranoid and diffident about openly engaging with the globalised world. After accepting accolades about India’s status as a rising economic story,there should be little scope for protectionist paranoia. You can be one or the other,not both.

In this regard,it must be noted how China has brilliantly used the period of economic and financial turmoil in recent years to gradually internationalise the yuan and engage more deeply with the global economy,without making too much noise.

The writer is managing editor,‘The Financial Express’
mk.venu@expressindia.com