Tuesday, 11 August 2020

FDI-FII flow and currency war

Updated: November 27, 2010 10:54 am

There is a big debate in the country going on Foreign Direct Investment (FDI). On one hand lot of money is flowing into the country through the Foreign Institutional Investment (FII) route, on the international front a big currency war is taking place between countries. The issue of FDI, FII flows and exchange rate management are very closely intertwined to each other.

                The deposits which are generated out of this FDI and FII flows and kept with the central bank are a liability for the country and are in the form of a debt and are wrongly designated as reserves and therefore are a misnomer. Secondly they are mostly kept in the form of dollars and European currencies, if these currencies are devalued by these respective countries, we are ultimately a looser.

                Whenever there is a global crisis, economic nationalism takes centre stage over political nationalism. World is in conflict. Every nation is watching its own interest. Economic wellbeing of its own people is taking precedence over global concerns. We don’t need to follow what the western world did and taught us some twenty years back, when our ground realities are different, even our food is not secured and our farmers are committing suicide. These are some serious issues having far-reaching consequences in the country.

                The policy-makers are concerned that economic rivals are using exchange rates to their advantage and searching for ways to preserve domestic growth and employment. There is a fear that investors will flee America’s low interest rates and weakening dollar flow into their markets, overheating their economies. Many countries have embraced some forms of capital controls to reduce incoming short-term investment.

                The exchange rate management is a matter of great concern. Many Countries like Thailand, Brazil, China and European countries are trying to devalue their exchange rates to help their exports. The entire world is pressurising China to let its undervalued currency to appreciate. Beijing, having accumulation of large foreign exchange reserves through persistent surplus in its capital account, does not want to move in this direction.

                The rate of inflation in our country is very high and to secure domestic saving, which is the backbone of our capital formation, we have to keep interest rate high. The domestic economy is in resilient mood due to high demand push in comparison to recession in many parts of the world. Both these factors are attracting FDI as well as FII funds flow. With the Indian economy forecast to grow at over 8.5 per cent on rising incomes and abundant loans, global investors prefer India. India is one of the few Asian economies that do not depend on exports in comparison to China, which is highly dependent on exports.

                FII inflows in India are expected to reach the landmark of $25 billion in 2010. FIIs have already poured about $18 billion in Indian stocks so far this year surpassing the $17.9-billion record in 2007. With the Sensex racing towards an all-time high, foreign investors are pouring money in funds focussed on Indian stocks. This is hot money creating lot of volatility and instability in the economy and cannot be considered to be very good for the country.

                FDI is mainly beneficial to MNCs. The manufacturing units set through FDI are owned by MNCs having majority stake. The profits of this manufacturing unit belong to them. Secondly, they have invested in currency assets which have a potential to appreciate. They will also get higher returns simply because of the high rate of interest. Thirdly, the so-called reserves of our country are parked with their parent country having control over these reserves. A simple process of devaluing their own currency can reduce the value of these investments. What does the domestic country get? Only good wages for the services rendered. This also makes our product cheaper in international markets and therefore helps international communities fulfil their demand for consumption. According to WWF-commissioned report countries like Australia, United States, Canada etc. have a very high level of consumption of natural resources having heavy global footprints. These are therefore termed as unsustainable economies.

                Whatever benefit we may have in the future will also be taken away from us. Historically we have example with USSR. In our trade with Russia, ruble was the denominating currency and our agreement stated that all bilateral payment would be in ruble denomination. The ruble value was not determined by market forces but was fixed. We bought all defence equipments, oil etc in ruble denomination. When Russian economy got burst we should have been benefited by paying in rubles as per our agreement, but due to the level of corruption that we have, all liability was converted into rupee denomination. Historically, this transaction has the distinct legacy of being the single largest donation by a poor country to a rich nation.

                The two financial crises that the world passed through recently have many lessons for us. Earlier in the South East Asian crisis, real asset bubble was built up through massive funds flow and bank lending based on the securities of these assets and currency exposure by international investors like Warren Buffett etc and combination of these factors suddenly destabilised the whole economy in a synchronised manner. The recent financial crisis in the west was the other way round where bubble was built through large-scale deficit financing and indiscriminate printing of currency by US and then subprime domestic lending to fuel consumption. It was in the US interest to release this bubble, and was done through loose bankruptcy laws. The world lost trillions and trillions of dollars in the form of reserves.

                We are mortgaging our present for the future. In a new global hunger index by the International Food Policy Research Institute, India has been ranked way below neighbouring countries like China and Pakistan and is at 67th rank. The index, rated 84 countries on the basis of three leading indicators—prevalence of child malnutrition, rate of child mortality, and the proportion of people who are calorie deficient. In India, the Index scores are driven by high levels of child underweight resulting from the low nutritional and social status of women in the country. The report points out that India alone accounts for a large share of the world’s undernourished children. India is home to 42 per cent of the world’s underweight children, while Pakistan has just 5 per cent. The economic performance and hunger levels are inversely correlated.

                At this juncture considering requirement of the country and international scenario based on FDI and FII flows and its effect on economy through currency valuations India needs to be cautious on this count, and can easily defer FDI in retail till a consensus is built. The government has also set up a committee under Shri UK Sinha to go into all the aspects of foreign flow and give its report.

By Gopal K Agarwal

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