The finance ministry estimates that any signal by the US monetary authority on increasing interest rates could lead to a pull out of around $5 billion to $6 billion from local debt by foreign investors in the short-term.
“This kind of money could move out of the country within a fortnight but the situation is likely to stabilize soon,” an official said. The sell-off is expected both in government and corporate debt, the official added.
India allows foreign funds to buy $30 billion worth of government bonds and $51 billion in corporate bonds. While the limits in government bonds have been almost fully utilized by investors, the interest of foreigners in corporate bonds has also picked up this year and around 75 per cent of the limits have been used.
In 2013, the announcement by the Federal Reserve in May that it would bring down the amount of bonds it buys from the market every month to inject money into the American economy and support growth had led to pull out of $20 billion from local debt market by foreign investors as they feared liquidity to be tight going forward.
The situation would not be that bad this time as Indian market still remains attractive for foreign investors, the official said.
After tightening liquidity, the federal open market committee of the Fed is meeting in Washington over Tuesday and Wednesday this week.
Expectations are that at the end of the meeting some indications are expected on when the Fed would start increasing interest rates.
Most economists and market participants expect the rate hikes in US to start from June on wards. It will be for the first time since the 2008 financial crisis that interest rates will go up in US.
Higher interest rates in US could lead to withdrawal for some investors from emerging markets like India who start sensing higher return on investments there going forward.
Tightening of US monetary policy will also lead to stronger dollar and higher global interest rates that could have a significant impact on financial systems in India as many banks and companies have increased their borrowings in dollars over the last five years. But this scenario will play out over a longer period.
RBI governor Raghuram Rajan also admitted on Wednesday that some volatility in Indian markets is expected if the Federal Reserve changes policy stance. However, he expects normalcy to return soon after the initial phase of volatility as India is in a much better position to deal it.
Foreign exchange reserves and fiscal position are much better if US fed changes policy stance, Rajan told news persons after a meeting with finance minister Arun Jaitley.
The impact of any tightening of liquidity in 2013 was amplified by the weakness of the Indian economy that was facing low growth, and high current account and fiscal deficit.
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