The Hindu Business Line : Hedge, private equity funds may pull out: RBI

Mumbai, Aug. 30 The Reserve Bank of India has warned that hedge funds and private equity funds, which are major investors in emerging market economies like India, could pull out of these markets, in the face of the continuing crisis in the US mortgage market, causing greater financial volatility.

In its Annual Report, which was released today, the RBI said: “Further deterioration in sub-prime delinquencies could lead to reassessment of risk by investors across products and markets and retrenchment of capital from the emerging market economies (EMEs), given the contagion and herd mentality.”

Monetary Tightening

As a growing number of hedge funds invest in the country, the capital inflow can be volatile, given the nature of the funds, said the RBI. Private equity funds, another major source of capital for EMEs, are sensitive to interest changes. Therefore, any monetary tightening in the major economies could lead to a slowdown of investment from private equity funds, the RBI pointed out.

The RBI said while its monetary policy stance would continue to be that of maintaining price stability and anchoring inflation expectations, in this context, financial stability would assume greater importance in the months to come.

However, the RBI is bullish on the domestic economic growth. While retaining its earlier forecast of 8.5 per cent growth rate, the RBI said that supply side constraints could exert pressures on growth and inflation. “In this environment of demand-supply mismatches, inflation can emerge as the key downside risk to the evolving macro economic outlook,” the report said. The RBI has called for economic polices that could help boost investments in the domestic economy which is critical for preventing the risk of financial imbalances arising out of large capital inflows.

This would help the Central bank to resolve the problems arising out of large rupee liquidity and excess capital flows in foreign currency, which it faced last year. Capital inflows during 2007-08 so far have been higher than those in the corresponding period of 2006-07. Up to August 10 net FII inflows have been around $10.1 billion in contrast to outflows of $1.5 billion a year ago.

Foreign Direct Investment flows were $3.7 billion during April-May 2007 compared with $1.2 billion during April-May 2006. Total foreign exchange reserves rose by $27.3 billion between end-March 2007 and August 17, 2007.