Investment Risks to Economy – Caution Is the Watchword for RBI

Indian Economy

Indian Economy

Addressing a meeting of business leaders at the India-America Chamber of Commerce meeting this week, Reserve Bank of India Governor Raghuram Rajan spoke of the opportunities of investing in India. He also spoke about the need to focus on deliverables and said the time for action was now.

His address covered major areas that require reforms starting with the need to focus on financial and infrastructure development sectors along with significantly raising the quality of human capital. He also highlighted the need to optimize the regulation for good business in order to build a conducive atmosphere for attracting investment in India.

Rajan spoke of how India had outgrown its institutions and the fact that India needed to reform its labour laws to the benefit of both the employer and employees, to kick start the manufacturing sector. He called upon the Indo-American business community to get further involved in the emerging opportunities in India.

Investor confidence

In order to build investor confidence and improve the business sentiment, Governor Rajan spoke of the need to ensure speedy clearance and early implementation of stalled core sector projects and do away with the tedious process of multiple inspections, while introducing a viable mechanism of self-certification.

India is already showing signs of making a rapid recovery from the recent global recession and is being viewed by the global investor community as an attractive destination for investment. India has already initiated policy changes to attract investment in core areas like railways, roads, defence, insurance and construction and this has been met with a positive international sentiment. The foreign capital has begun to flow in and is expected to increase further through FY’15-’16.

The nation is bullish on the economy with the Modi Government successfully communicating to the international business community that India was ready for business. In his first 100 days in office, Modi has made India very visible on the international diplomatic and economic charts and now is the time to walk the talk.

Modi’s call of ‘Make in India’ being welcomed by the international business community and with positive commitments for big investment coming from Japan, China and now the US, the next few years will see India accelerate its economic development.

There are several emerging opportunities in new age industries like bio technology, new age materials, agri sciences, pharmaceuticals, robotics, clean energy and defence, and with a friendly Government welcoming investment, India is being seen as an exciting investment destination.

A word of caution

While the increase in FDI is very welcome, it’s the FII inflow that is worrying the cautious Raghuram Rajan. He was one of the few who was able to foresee the impending global financial crisis in 2008 which was triggered by the collapse of Lehman Brothers.

That crisis was triggered mainly on account of two major factors; one was the lack of effective monitoring and intervention measures by the Central banks in the USA and other affected countries, and the other factor was the lack of effective communication, monitoring and coordination between various Central banks.

The world learnt a lesson the hard way and now there is better understanding and coordination among the Central banks. That said, the International Monetary Fund (IMF) has recently released the Global Financial Stability Report which cautions of an increase in risk of exposure to financial shocks by emerging economies, including India.

Increased exposure; increased risk

The study found that investors from developed economies had doubled their total investment portfolio in debt and equity in emerging markets to 12%, over the last decade. This means that the emerging markets are now at a greater risk to financial panic leading to a situation where the international investors pull out their big investments leaving the financial markets open to collapse. This was seen in Malaysia a few years back when a sudden exodus of capital almost drove the nation to a complete financial collapse.

Compounding the already delicate international financial situation, wherein countries are just beginning to emerge from a recession, is the threat of Quantitative Easing (QE) of the monetary policy by the US Federal Bank, which had kept the interest rates close to zero, through massive capital infusion, in order to spur the economy.

With the US showing signs of recovery, the Federal Bank is now in the process of initiating a QE in a phased manner. This could have adverse impact on several economies and all Central bankers worldwide have their eyes glued to any moves made on QE by the US Federal Bank.

Furthermore, with potential flashpoints happening in the Middle East and Ukraine, any series of events could trigger a panic in the financial markets and this is leaving many global economies very uneasy, as the move is expected to have an impact on the global financial system.

Echoing the sentiment of risk of another impending financial crisis, Governor Rajan sounded a note of caution earlier in August this year, saying that India too was exposed to the risk in a greater way than before but also mentioned that the RBI was monitoring the situation closely.

Another developing situation worrying the RBI is the new trend of leading Indian corporates which are investing large surplus capital into currencies and bonds for additional profits, over and above revenues from their traditional business operations. Companies and large pension funds are investing big ticket money into the financial markets. The data shows that the volumes of daily transactions by such companies has touched 10% of Rs 30,000 crore Government bond market.

Since the investments are legal and mostly unregulated, the RBI is naturally worried as any bad investment could trigger instability in the financial markets, which can have an adverse impact on the macroeconomic situation of the country. The RBI is monitoring the situation closely as any impact of the QE could also result in a panic situation amongst Indian and international investors.

Concluding view

India is at the right stage to launch an accelerated development programme that will ensure the nation can improve the quality of life for its people, as also catalyze development in the South Asian region. India needs to cautiously respond to the emerging financial situation in the global markets and ensure that a right balance is struck between prudent monetary policy and accelerating growth. Governor Rajan has his hands full for now.


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