Column: Captivating potential investors

Oct 04 2013, 05:02 IST
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SummaryHaving a stable currency is a pre-requisite to getting foreign investment

It is now accepted that one reason why FIIs are pulling out of emerging markets is that interest rates are increasing in the developed economies. This is happening on the back of the twin expectations of a recovery in the west, which in turn, will lead to the premature withdrawal of QE in the US. The result would be a reversal of flows at a faster pace. Therefore, there is merit in the argument that if India is looking to stem the outflow of dollars, RBI may have to give primacy to rupee stabilisation which necessarily means taking a call on interest rates.

In fact, investors in debt would tend to look at the real return on such investment as well as the perception on the exchange rate before taking any decision on where to invest. This means that inflation matters, not just present inflation, but also expectations of the same. When critics highlight our obsession with inflation and exchange rates, they probably err as these are genuine considerations for any central bank. Also, while industry would like interest rates to come down to bring about growth (though anecdotal experience does not justify the same), a central bank, which takes a more macro look, has to look at all these factors when taking a call on policy options.

Looking at various markets in the world, an interesting commonality is that nominal bond yields have actually moved up over the last year by varying degrees in different countries. The yield on 10-year GSec or its equivalent has increased by more than 100 bps in countries like Brazil (281), Indonesia (230), South Africa (137), UK (118), USA (114) and Sweden (102). It has been over 60 bps for Mexico, Thailand, Korea, China, Switzerland, and Germany. In case of India it has been almost flat at the current rate of 8.27%. Quite clearly, we will have to compete with markets where yields are increasingboth developed countries as well as competing emerging markets.

On the positive side, as the accompanying table shows, at the present level of real yield (which is what matters to investors) where the nominal rate is adjusted for the inflation number, our real rate is at 2.48%. It is at the upper end of the ladderthird in the list of 18 selected countries, with Latin American countries such as Brazil and Mexico ahead of us. Inflation has been high in

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