The Fear of Reliance on DEBT !!!!

The Reserve Bank of India’s third quarter 2011-12 review of Macroeconomic and Monetary Developments released on January 23, 2012 assessed that risk aversion in the global financial markets has slacked the pace of capital flows to India and if the pace of FDI inflows does not pick up and FII equity inflows follow their decelerating trend then the CAD (Current Account Deficit) may have to be financed through debt flows in the coming quarters.

As per one of the report by RBI, during calendar year 2011 as a whole, foreign debt inflows amounted to $8.65 billion, out of which almost half of it came in December. And in the same calendar year it is said to have recorded a net outflow of equity investment of almost $357 million. On one side there is a recent revival of FII inflows largely in the debt instrument and on the other there has been a collapse of foreign portfolio investment flows, leading to an overall fall in the external investment in equity. But with burgeoning CAD the conclusion arrived that India has to increase its reliance on debt creating flows to finance its deficit.

Measures such as paving way for Qualified Foreign Investors (QFI) to invest directly in India’s equity market is an explanation by the UPA government to establish the fact that it is countering the formed view of “policy paralysis” and boosting again the positivity in the market.  But they are also driven by the need to reverse the slowdown in inflows of foreign portfolio investment. The decline in FII inflows has been attributed to the development abroad, which required FII to book their profits in India and repatriate their funds to meet commitments or cover losses at home.

One danger is that though the government is trying with different measures to infuse positivity in the market by allowing direct access to equity markets but still it becomes difficult or rather impossible for Indian regulators to fully rein in these global players and impose conditions on their financing, trading and accounting practices, controlling unbridled speculation required by them to be regulated at the point of origin. And, if such investors do come in the Indian market then it would be with the intent of reaping capital gains through short term trades.

Thus to make this measure successful it would mark a transition towards allowing a more speculative base of such players in the market but defending that aspect on the ground that it would help to reduce the dependence on debt is indeed questionable.