The government on Thursday said that any slowdown in the excess capital flows from the last year's high levels could affect the stock market in short-term, even as it would make the monetary management easier.
"There has been a renewed expansion of liquidity by these countries (US and other developed economies) and this may increase the capital inflows into India and other emerging markets," the pre-Budget Economic Survey said, while outlining its concern over the US sub-prime crisis.
The government said in its Economic Survey 2007-08, tabled in Parliament on Thursday by Finance Minister P Chidambaram, that the situation of excess inflows is likely to remain, though the pressure on reserve accumulation and rupee is likely to ease.
However, the increased uncertainty due to lack of precise information on securitised debt and all its manifestation, reduced credibility of many developed market intermediaries and increased risk aversion among their investors would "tend to reduce the flows into developing countries," it added.
Besides, India's slower economic growth in the current fiscal, as compared to the past two years, might also have "a temporary dampening effect on capital inflows."
Still, the decline in capital inflows as a proportion of GDP in 2008 was likely to remain modes and the net flows would take care of any expansion in current account deficit, Survey said.
The Survey said that the country's high GDP growth was attracting foreign capital looking for attractive investment opportunities. However, if these growth opportunities do not materialise fast, it leads to an upward pressure on rupee, which could further result in an accumulation of reserves, to be followed by monetary expansion and inflation.
"There are reasons to believe that the surge in capital inflows, including FDI, will continue in the medium term. The fact that the capital inflows has been in excess of current account deficits despite two years of over nine per cent growth suggests that investors expected opportunities for profitable investment to grow," the Survey said.
About the sub-prime crisis, the Survey further said that consequent to the issue, the US economy was expected to slow down in 2008.
"Most projections of the world economy suggest a moderate but not severe slowdown in world growth. This will impact both the demand for India's exports and value of imports."
As such, India has remained relatively insulated from the sub-prime crisis, which originated in the US and subsequently spread to Europe and other parts of the world, it said.
"India's gradual approach to the financial sector reform process, with the building of appropriate safeguards to ensure stability, has played a positive role in keeping India immune from such shocks," the Survey said.