The ongoing financial sector crisis in the United States and its repercussions on developed markets worldwide will result in lower capital inflows into emerging markets like India, economists and government officials said on Thursday.
At the same time, they called for the government to make it easier for Indian companies to borrow overseas by easing the restrictions that have been imposed in the past to reduce excessive liquidity in the system and control inflation.
This will, in turn, lead to a slowing in investment growth in the months ahead. As lending gets tighter and investment flows dry, corporate India will find it more difficult to raise both equity and debt. The Prime Minister's Economic Advisory Council has already hinted at this when it said that while it doesn't expect too much of a slowing in investment rates, it does see a slackening in the growth of savings. The EAC sees the gap in savings and investments being made up by foreign savings.
Shubhada Rao, chief economist, Yes Bank, said the developments come as a huge concern. "The risk of a financial contagion would exist. If they (Merrill Lynch or Lehman Brothers) were commercial banks, the risk would have heightened," she said, adding that Indian companies would find the going harder to raise funds.
"The pain is going to linger on. We could see a reversal of portfolio inflows. The time has come for policy action to ease restrictions. Contagion like symptoms are evolving in the US and the problems will persist for some time. We cannot allow capital flows to suffer," Rao added.
In July, the EAC had estimated portfolio inflows of $4.1 billion in 2008-09, a very large fall from the $29.3 billion in the previous year. Total capital inflows in the current year are pegged around $71 billion, which is 34 per cent less as against the previous year. However, even at this level, the Council expects this to be more than adequate to finance the enlarged current account deficit, which was projected to expand to $41.5 billion, or 3.2 per cent of the GDP as against 1.5 per cent in 2007-08.
The Council does not expect financial conditions to stabilise before early 2009 and has said the downside risk to its GDP growth projection of 7.7 per cent for 2008-09 is primarily from a further deterioration in global conditions with its attendant impact on India - be it oil prices or the capital markets.
Separately, C Rangarajan, Rajya Sabha member and former chairman of the Council, today said the global financial system was under stress, adding that it was difficult to predict whether the crisis would deepen further.
Professional bankers add that liquidity will dry up further. Punjab National Bank Executive Director K Raghuraman said there could be further tightening of interest rates in India.
"As a result, credit growth may be impacted going forward. What is worrisome is that the US financial crisis has not bottomed out yet. The bankruptcy of Lehman Brothers is not a small thing. Indian banks having business links with the firm may also be impacted," he warned.