The massive portfolio flows into India are coming in on the hope of continued structural reforms.
"If the government backtracks on reforms, we will see a wholesale exit by foreigners," Alan Brian Jacobs, senior international economist and strategist for AMP Capital Investors and AMP Sanmar Life Insurance Company told Business Standard.
The stock market had fallen sharply for five trading sessions before recovering today. This was because foreign institutional investors had net outflows to the tune of $56 million on Tuesday and Wednesday.
Jacobs also said that there is a need to hasten the pace of reforms if India continue to attract foreign investment.
Today there are risks to global fund investments on account of expectations of higher interest rates and higher oil prices, said Jacobs, who was speaking over lunch to a corporate audience on the "Outlook on global and Indian economies" organised by AMP Sanmar Life Insurance in Mumbai.
Crude oil prices have scaled new highs in the last couple of days. On Thursday, prices hit $57.60 a barrel on the New York Mercantile Exchange before settling lower at $56.40 per barrel.
There is a slowdown in the global economic growth with growth rates of 2.7 per cent in 2005. Asian economies will take a hit largely as they are export-oriented.
China, for instance, experienced a growth rate of 9.5 per cent in 2004, but has since the beginning of the current year witnessed lower growth of 7.5 per cent, said Jacob.
India, however, on account of its limited exposure and stronger emphasis on the services sector, will be insulated from this slowdown, he added.
"India is more exposed to the services sector, which is less cyclic. Hence India is seen as being less risky than China, which is more exposed to the manufacturing sector," said Jacob.
For emerging market flows, a weaker dollar will not offset the negative features of high US interest rates and high oil prices.
However, Jacobs added that from the trade point of view it was important for Asian countries to appreciate their currencies against the greenback.
"A weak dollar is a major problem for the world economy as it would result in recession. At the same time, with huge capital inflows into emerging markets, high liquidity would result in inflationary pressures," he added.
As emerging markets today are highly leveraged, any downslide in the US economy would see far greater volatility in these markets, said Jacob.
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