At present, FDI inflows are hardly of a kind that promise a net inflow in the medium term. They are aimed at expanding the profit repatriation base in firms already controlled by transnationals or at purchasing shares of the domestic market, rather than increasing export competitiveness and revenues. That is, direct investment inflows are of a kind that increase vulnerability. Unfortunately, the same appears to be true of portfolio inflows among which we must distinguish between capital flowing in through new issues and that being invested in secondary markets by foreign institutional investors.
 
As far as new issues of equity and bonds are concerned, they reflect the desire of Indian corporate organisations to mobilise foreign exchange resources, partly because of their need for foreign currency and partly because interest rates on international borrowing are competitive even after allowing for the higher costs of mobilising such finance. This implies that a significant part of the foreign resources mobilised would be directly spent on imports, and the rest would join the pool of reserves with the Reserve Bank of India. Once the resources are mobilised, however, the responsibility of the unit concerned ends. Any foreign exchange required to finance dividend repatriation, interest payments, amortisation and payments for shares sold has to be met by the RBI whenever necessary.
 
In the case of shares purchased by institutional investors in the secondary market there is no connection between such 'mobilisation' of foreign exchange and imports. Hence the whole of the sum involved enters the pool of reserves, but as is true of the primary market, that reserve has also to meet all payments on account of dividends or capital repatriation after sale of shares.
 
These features of the new form of portfolio finance have two major implications. First, since it is impossible to link foreign exchange access to foreign exchange earning capacity, there is a real possibility that expenditure of foreign exchange today may exceed that warranted by the future ability to pay out foreign exchange, unless the trend of additional inflows remains more than adequate to meet these requirements. Second, since a part of the inflow is not directly linked to imports, mobilisation of finance through these means can lead to a build up of reserves that strengthens the domestic currency and undermines export competitiveness, unless of course the underlying process of growth in the economy raises the demand for imports and exhausts a part of these reserves.
 
Thus portfolio inflows can represent a "no-win" situation if everything else remains constant. If they are used to finance imports directly, they are encouraging foreign exchange profligacy by delinking expenditure of foreign currency from the ability to earn it. On the other hand, if they are not used to finance imports, they result in an accumulation of reserves, a consequent appreciation of the domestic currency, a decline in export competitiveness and a worsening of the current account of the balance of payments. To boot, an increase in reserves by leading to an increase in money supply reduces the government's influence over monetary trends and its macroeconomic control through monetary policy.
 
One situation in which this need not hold is when the government resorts to deficit-financed expenditure to boost growth and uses the excess foreign exchange to meet the import requirements of that strategy. And such a strategy can prove virtuous if the autonomous growth in exports that accompanies growth is adequate to meet the service payments on the implied foreign exchange expenditure. In practice, however, portfolio capital favours those countries with "stable macroeconomic policies", which include an unwillingness of the government to resort to large budgets deficits. Nor is there any guarantee that portfolio inflows would be coincidentally accompanied by an 'autonomous' export boom. That is, the preconditions for portfolio inflows to be positive from the point of view of the balance of payments and growth are either difficult to realise or entirely fortuitous.
 
If such conditions are not realised, however, portfolio flows can in fact prove to be more adverse than commercial borrowing. This is because the "herd instinct" of banks overexposing themselves in a few countries is far less irrational than that of atomistic investors driven by campaigns run by brokerage firms that make a killing in selling emerging markets. Morgan Stanley, for example, is reported to have earned a fee of $7 million on Reliance's first Euro-issue. Typically, commissions earned by these firms on emerging market issues amount to more than 1 per cent compared to 0.3 or 0.4 per cent for an American issue. This encourages them to push developing country paper into the hands of inadequately informed investors. Developing country profligacy can combine with developed country investor irresponsibility to generate scenarios similar to the debt crisis. If they do, portfolio flows in the new liberalised financial environment can prove more "hot" than short term borrowing. If portfolios are being diversified in favour of countries like India to hedge against risk, they would turn sharply against them at the first sign of overexposure. And for a country whose international credit rating is still below investment-grade, that denouement need not be far away. That is, the sobering thought that has been ignored by many Indian observers of the emerging market syndrome is that portfolio flows in themselves increase external vulnerability rather than resolving it. Indian road shows that win foreign investor support may be just as transient as a carnival.