Too much of foreign money is bad for Indian economy: this is the core message of Reserve Bank of India's (RBI) Midterm Review of Monetary Policy. The RBI has once again increased the Cash Reserve Ratio (CRR) by 50 basis points to 7.5 per cent in an unexpected move. Though the RBI has left the other policy rates unchanged, the hike in CRR was the sixth time since the beginning of 2007 when it was 5.5 per cent. The 0.50 per cent hike in CRR will sponge off around Rs 15,000 crore from the monetary system. By raising CRR, the RBI has signalled that it wants to mop up excess liquidity. Theoretically, the liquidity tightening exercise should also lead to an increase in interest rates, tightening of inflation and depreciation in the value of rupee against dollar and other foreign currencies. But in reality it may have little impact.

Surely, RBI has reason to be worried about rising liquidity in the system mainly due to huge inflow of foreign funds in our stock markets. Since the beginning of 2006, foreign investors have invested close to $25 billion in Indian stocks and a good $17 billion has come since January 2007. This has led to swelling of our foreign exchange reserve by $ 62 billion since end June, taking the total forex reserve to $ 261 billion. Clearly, India is faced with a problem of huge capital inflows and needs appropriate regulations as well as risk management systems to avoid any potential shocks.

RBI's measures, however, may not become very effective because there are a whole lot things that happen abroad that affect our economy. With strong economic growth and an appreciating rupee, foreign investors may continue to take a fancy for Indian stocks and keep pouring in money. The recent decision of the SEBI to curb foreign investment through participatory notes, for example, has not dissuaded foreign capital. If the USA's Federal Reserve cuts interest rates once again in the near future, surely India (along with other emerging countries) will become even more attractive as an investment destination. Similarly, since interest rates in India are significantly higher than in developed countries, non-resident Indians will continue to send their money back home. If dollars keep pouring in, rupee will continue to become dearer, causing problems for exporters. With greater liquidity, the spectre of inflation looms large. Though the rise in wholesale price index has remained range bound between 3.5 and 4 per cent, a major reason was non-increase of oil prices. With the international price of crude oil hovering around $ 90 a barrel, very soon the government may have to pass on the increase to the consumers. Given the strong positives, RBI's efforts to curb liquidity may not become effective at all.