Finance Minister Chidambaram says ''all kinds of capital flows into the country are welcome''. 'But', he adds, ''there is a hierarchy of preferences''. And he lists the hierarchic order of preferences as Remittances first, Foreign Direct Investment next, Foreign Institutional Investment, third and Venture Capital, the last.

But, he cautions, ''one should not try and stop some kinds of capital''. Chidambaram is not unaware that the market does not act in line with any one's preference, including the Minister's. Either the Minister acts to stop or tax, or puts roadblocks on, the capital not preferred, as indeed he can, or he accepts it as the market offers. Why does Chidambaram then express preference for some capital flows and not for some others?

When the Finance Minister expressed his preferences, he implied something serious. And that is the high risk that the capital not preferred by Chidambaram carries. The pink dailies and market experts are proud of the billions of dollars that flow into Indian stock market through FIIs. 'The BSE race to 10000' has almost become some kind of national goal! In 2005 alone the FIIs have net-invested $10 billion in Indian stocks.

Everyone knows that this short-term money - also known as hot money - moves around the different stock markets of the world by digital waves. It has no loyalty other than to instant gain. It only looks at how different markets move and flows to the market which offers better terms on a day, and to the next, better market the next day.

It is the global liquid money belonging to some one and managed by some one else. It wanders like a nomad looking for stocks in different markets and gain by buying and selling them on daily and even hourly basis. And once the gain is made, it joins back the global liquid stock, and again begins to look for gainful stocks. This hot money is currently driving the stock markets in India. Courtesy this money, the 'BSE 10000' slogan is gaining crescendo.

See the risk this hot money carries. Out of the total foreign money invested in Indian companies the hot money lodged by FIIs in Indian stocks is said to be around $45 billion and the balance, FDI. This $45 billion that has come in has appreciated in stocks to $80 billion, almost doubling in value. A part of this money can fly off the moment it finds a small advantage elsewhere. And when it leaves it generally brings down the stock markets as the local money cannot take its place adequately.

It will force down not just the stock values, but also the currency, the Rupee, values. More, when it leaves, it will also paste a certificate of no confidence on the Indian economy, just as its entry was seen as a measure of confidence in India! India need not perform badly, nor does someone else need to perform better, for hot money to leave India. If the US raises its interest rates substantially for its own domestic reasons the hot money can desert the Indian stocks and fly off to US, bring down the Indian stock and forex market and express no confidence in India, thus encourage other investors to pull out their money too. The hot money mixed in Indian forex reserves is over $90 billion, that is about 60 percent of the total.

This high risk component is ballooning as during the year 2005, the FII investment of $10 billion is twice the FDI investment of $5 billion in India. This easy, cheap, hot money has destroyed many an economy it has helped to build, like the Latin American and South East Asian economies.

There is neither prevention nor cure for the destruction that it brings in. Some great minds led by two Nobel Laureates attempted to fix a zero-risk solution to this risky money. A theory, 'Black-Scholes' model, was evolved for decades to assure zero-risk for engaging this risky money. Two economists, Myron Scholes and Robert Merton, were awarded Nobel Prize for this great model which presented a 100 percent risk free relation between market and hot money that wanders through electronic digitals world over. The two economists joined others in a hedge-fund 'Long Term Capitol Management' (LTCM) which was trusted to possess a zero-risk model for engaging short term funds.

But, not surprisingly, the LTCM collapsed in a year. It had to be bailed out by the Federal Reserve Bank of New York persuading different banks to write off over $3.6 billion to ensure that the risk did not contaminate the whole market! The Nobel Laureates who turned into a lab to experiment their own theory by investing their Nobel Prize amount too lost their money. They quietly returned to teaching, their original profession! Thus the LTCM founded on Nobel Prize winning zero-risk model had to be rescued from insolvency. QED: there is no method or model to avoid or escape the risks posed by the money that gets in and out of the stock and forex markets by hours and minutes.

So when Mr. Chidambaram spoke of the preferences, he actually had this risk in mind. Is isn't it Mr. Chidambaram?

Courtesy: www.newindpress.com, January 07, 2006