Recently, there have been a few developments that turned the spotlight again on cross-border capital flows into India. At the Seoul G20 summit, it was agreed that countries with increasingly over-valued floating exchange rates could adopt “macro prudential” measures to stem the surging inflows. This is an important development, although it came well after the IMF had revised its earlier dogmatic position on free cross-border flows. Interestingly, several Asian and Latin American countries, including Brazil and Indonesia, have clamped controls of one form or another on capital inflows. The flow of capital into the emerging economies from the developed ones, already on the high side, is expected to rise further since the latter continue to pursue ultra-soft monetary policies. The United States' decision to go for “quantitative easing” to an extent of $600 billion will naturally augment the already large supply of dollars. Despite the surge in foreign money going into the stock markets over recent weeks, India has refrained from clamping any restriction. Since July, aggregate capital flows from the foreign institutional investors have risen to as high a level as $29 billion.
The official view seems to be that even the relatively large inflows can be absorbed at this juncture. Recently, C. Rangarajan and Montek Singh Ahluwalia have indicated it could be between $70-75 bilion a year. Their reasoning is evidently based on the fact that the current account deficit is widening and is projected to be in the range of $45-50 billion by March 31, 2010. This will mean, there will only be a relatively small surplus of about $25 billion to be managed. However, while the inflows from abroad have traditionally helped in bridging the deficit in the balance of payments, there is a danger in depending excessively on one source. As the Reserve Bank of India pointed out recently, in the face of a global slowdown, increasing risk aversion might force global investors to flee, thereby reducing the capital flow. Apart from reducing the comfortable level of the buffer between the current account deficit and net capital inflows, that might also constrain domestic investment, which is critically needed for achieving and sustaining high growth. The time has come when capital inflows are viewed not merely from the standpoint of meeting the current account deficit. In fact, in the absence of RBI intervention, capital inflows can cause the rupee appreciate faster, dampening exports, and thereby widening the deficit in the merchandise trade and hence in the current account as well.
