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July 2, 1998


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India will face hard time in attracting foreign capital: Morgan report

India will face a very hard time in attracting foreign capital into the country.

Not only due to the sanctions imposed by the US government but because of various domestic economic constraints -- such as high fiscal deficit that threatens an internal debt trap, high cost of financial and monetary transactions and regulatory constraints that cause market imperfections and artificial markets segmentation.

This was revealed today by a research report on Indian markets prepared by the Morgan Guaranty Trust Company of New York.

The Trust, which commenced its Indian business operations recently, said the current bout of Asian economic depression had given an opportunity to India to attract foreign investments.

However, it would be difficult to achieve this mainly due to the growing risk averseness in the international investment community. To offset this, further reforms are necessary in the Indian system, it said.

Highlighting problems that need urgent attention by the authorities, the report said the large and fragile coalition government at the Centre sent negative signals to foreign investors.

They noticed a lack of political commitment and consensus to go ahead with the reform process.

India needs to speed up clearances and further open its infrastructure sector to foreign capital.

On financial sector reforms, the report said the highly regulated Indian financial sector coupled with its complicated tax structure had been acting as a disincentive to international investors.

The policy of financing loss-making state enterprises through scarce domestic resources, artificial segmentation of markets and directed lending has been slowly choking the entire financial system. Also, the current economic slowdown is bound to worsen asset quality problems, it said.

Besides Japan and the more distressed economies in the rest of Asia, the paper said India is also in need of substantial financial reform. While the Indian authorities have realised the need for banking reform, their measures are far from sufficient.

Probably, the most effective way to enforce bank prudence is through transparency of asset classification, income recognition and provisioning norms, well-defined financial responsibilities and clear hierarchies. The intermediaries still lack the expertise in evaluating and monitoring risks.

The report says there is certainly no fundamental reason for softening in real interest rate and the recent decline is more a result of a delayed response of government security yields to rising inflation.

Talking on the future course of direction of interest rates, the report said that in a capital-scarce economy like India, there was bound to be an upward pressure on real rates, particularly when the internal debt situation is far from comfortable.

''In the coming months, we should see market interest distinctly shift towards short maturity assets resulting in an initial steepening of the curve followed by the curve flattening at higher levels. Yields at the longer end are expected to harden 50 to 75 basis points over the next three to six months.''

Highlighting some factors that could have a bearing on markets, the report said any signs of improvement in liquidity would be utilised by the Reserve Bank of India to push through fresh government bond auctions.

Later in the year, the RBI is likely to conduct aggressive open market sales of its seemingly endless supply of government stock.

Further, there are indications that the poor offtake of bank credit by corporates will gradually change in the second half of the year and the financial institutions and banks are likely to be more aggressive borrowers in the domestic markets than in previous years.

Further, the two-notch downgrade by Moody's and widening of spreads on Indian paper in the overseas markets will force these entities to local market funding.

All these factors would be aided by the current bearish sentiment towards the region that would lead to a considerable slowdown in foreign direct investment and portfolio inflows.

At best, one can expect a flat reserves scenario for fiscal 1998-99. While the Indian rupee seems to have stabilised in the near term and is expected to broadly track the other Asian currencies, the research paper said that only internal factors could play a significant role in the fluctuation of Indian currency in future.

For instance, the fall of the government at the Centre would certainly accelerate the rupee decline in future, it added.


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