Reserve Bank of India (RBI) has identified three kinds of shocks - arising from high global crude prices and fluctuations in food grain production and growing capital inflows in the form of portfolio or direct capital. However, it is of the view that the present circumstances do not warrant setting up special funds to cushion the effects of rupee appreciation.
“India is vulnerable to shocks on account of oil price and fluctuations in food grains production, which is still largely dependent on monsoon conditions,” said Dr YV Reddy, RBI Governor, at the golden jubilee function of Foreign Exchange Dealers Association of India (Fedai).
“Additionally, a large part of the capital flows are portfolio flows (from foreign institutional investors or FIIs) and a significant component of Foreign Direct Investment (FDI) is in the nature of private equity or for acquisition of existing firms and not in greenfield projects,” Reddy added.
FII inflows coming through special instruments called participatory notes, which do not have to disclose the real investor. Some of the short-term foreign funds (from hedge funds) are said to be coming through this route into Indian capital markets, which could lead to volatility in case of their exit in tandem.
Referring to stabilization funds and sovereign wealth funds established in some countries, Reddy said that the former are set up only to cushion shocks in commodity export flows in adverse market conditions.
Referring to such funds the RBI governor said, “In this regard, it is necessary to view the concept of ‘excess reserves’ from several angles, including from the perspective of possible real sector shocks to the current account and the nature of capital flows.”
Referring to unabated strengthening of rupee during the current year so far, many speakers at the conference said that several Indian companies, including IT companies having huge profit margins, would be in a position to weather the shocks arising from rupee spiral. But textile companies, which export with slender margins, and small and medium enterprise (SME) exporters were the worst hit due to rise in rupee.