INDIA BUSINESS WORLD - JUNE 2006
THE MONTH THAT WAS...

77% $ HOT MONEY

   RBI has said 77% of the net annual foreign capital inflow in 2005-06 (April-December) was ‘volatile'. This is the first time that the central bank has defined what it means by volatility in foreign capital flows with respect to India .

According to the RBI definition, volatile foreign capital inflows comprise portfolio investment and shortterm trade credit. This means RBI, in principle, categorises the entire inflow of foreign institutional investor (FII) funds into the stock markets as volatile.

Short-term trade credit is defined as the credit extended to importers by suppliers of goods and services abroad.

As per the RBI definition, the share of such inflows in the net foreign capital inflows has been 76.3% in 2003-04. The volatile component of the flow had eased to 40.9% in 2004-05, but picked up steam thereafter as the stock markets gathered momentum.

In the current year, for instance, the net FII inflow has been $2.39 billion as per Sebi data.

However, despite FII inflow being clubbed as volatile, the government has enough cushion as the total is less than 40% of the country's foreign exchange reserves. Compared to this the inflow of FDI has been much less.

The party leadership, which discussed the government's decision to hike the prices of diesel and petrol, was of the view that the current pricing was politically imprudent. “The leadership discussed the issue,” party spokesman Rajiv Shukla said.

The definition by RBI is in reply to a question in Parliament about the share of volatile capital in total foreign capital inflow into India .

Further, as per the estimates, the finance ministry and RBI had to spend Rs 4,166.18 crore —about 0.2% of the fiscal deficit — to sterilise the impact of the flow of foreign exchange into the country in 2005-06. The sum was Rs 3,701.26 crore in 2004-05. In recent years, the country's stock of foreign exchange has shot up largely through the surge in FII investment.

The two instruments used to mop up excess flow of dollars are the market stabilisation scheme and the liquidity adjustment facility. While interest payments on MSS are borne by the government, “such payments on account of LAF affect the government only indirectly through lower net disposable income of RBI”, the reply says.