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RBI: Capital inflows not sensitive to interest rate changes
June, 06th 2011

Foreign capital inflows are insensitive to interest rate changes in the country, according to a Reserve Bank of India (RBI) study. It said that a percentage point rise in interest rate results in just about 0.05 percentage points increase in net capital flows to India.

The RBI said domestic industrial and economic activity, stock return, performance of other advanced economies and overseas investors' risk perception is major factors that attract foreign capital. With this observation , RBI has put to rest the fears that a tightening monetary policy may slow down the net capital inflows in the country. Traditionally, FDIs and FIIs are two major components of foreign capital inflow and the study shows these two parameters are completely insensitive to interest rate changes.

These are primarily determined by India's growth prospects and returns on equities. During the 10-year period between 2000 and 2010, FDI and FIIs taken together accounted for two-thirds of India's total net capital inflows while the share became more skewed during 2009-10 at 93%.

The RBI said FDI inflows, which are essentially longterm in nature, grows as international investors become more confident about the growth prospect of the local economy.

Overseas institutional investors pumped in money in the local stock market attracted by the phenomenal rise in BSE Sensex. A 1% jump in Sensex led to 1.3 percentage point rise in cumulative FII inflows to the country's stock market, the study said. The two debt components of foreign capital - external commercial borrowings and NRI deposits - are, however, more sensitive to interest rate changes.

But while their weightage in the total net capital is significantly low, the exchange rate fluctuations also play a part in the flow of ECBs and NRI deposits. The study by research officer Radheshyam Verma and assistant adviser Anand Prakash, showed that one percentage point change in interest rate brings about 0.85% change in ECBs.

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