RBI says big FII inflows cause volatility

RBI says big FII inflows cause volatility

Reserve Bank of India (RBI) Governor Y.V. Reddy voiced concern on Wednesday about volatility caused by large foreign institutional investment (FII) in markets and said an option to cap it must be kept open.

"While quotas and ceilings may not be desirable at this stage, there is merit in our keeping such an option open and exercising it selectively if needed, after due notice to the FIIs," Reddy said in a speech after Indian financial markets had closed for the day.

The immediate reaction from traders was that share prices could fall heavily when the market reopened on Thursday on fears that FII flows might be hit.

This prompted Reddy to issue a clarification a few hours later, when he said: "So we are not in favour of any ceiling, but at some stage if it is required, we should have the option."

Foreign funds bought a record $8.5 billion worth of Indian shares in 2004, helping the benchmark Bombay share index to gain 13 percent over the year.

The influx helped the rupee gain nearly 5 percent in 2004, following a 5.2 percent rise in 2003. The rupee would have gained more, but for central bank intervention in the currency market.

"FII inflows are tending to be large and volatility has perhaps increased. The impact of such flows on the stock markets (is) discernible, but perhaps less evident at this juncture in corporate ownership and control," the central bank chief said.

Reddy said price-based measures such as taxes could be examined, though their effectiveness was arguable and therefore might not be desirable.

Finance Minister P. Chidambaram was quick to clarify that there was no plan to tax foreign fund inflows.

"I am quite clear in my mind that there is no question of taxing FII inflows, (there is) no such proposal under examination," he said.

"These ideas are thrown up from time to time by people, but we have rejected these ideas in the past and I reject them now again," he said.

Analysts said the clarifications would help soothe nerves.


Turning to the economy, Reddy said a better-than-expected performance by the manufacturing sector and exports had helped offset the impact of a poor monsoon and high oil prices.

"The performance of the manufacturing sector and exports (has) been better than expected," he said. "Unless there are totally unexpected shocks, the projected GDP growth of 6 to 6.5 percent should materialise comfortably."

The RBI had in October lowered its forecast for gross domestic product growth from April's 6.5 percent to 7 percent, following an erratic monsoon.

India expanded at its fastest clip in more than a decade when it grew 8.2 percent in the financial year to March 2004.

Data so far in the current year indicate growth is slowing. It expanded 6.6 percent in the year through the July-September quarter, easing from 7.4 percent in the year through April-June.

Reddy said the central bank's year-end inflation estimate of 6.5 percent was valid, despite a recent dip.

Wholesale price inflation fell to 6.39 percent for the year to Dec. 25 from 6.50 percent a week earlier and a 3-1/2-year high of 8.74 percent in late August. Analysts expect it to ease to about 6 percent in the next few weeks due to lower food and energy prices.

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