Saturday, December 4, 2021

India’s Foreign Exchange Reserves Surge

India’s foreign exchange (FOREX) reserves have boomed and now stands at all-time high at US$ 455 billion as on December 20, 2019. This is relatively higher than US$ 412 billion as on March 2019. The reason for surging FOREX is due to the component “Foreign Currency Assets” (FCA). It has increased 10 per cent higher, when compared to March 2019.

Foreign Currency Assets are maintained as a multi-currency portfolio comprising major currencies, such as, US Dollar, Euro, Pound Sterling, Japanese Yen, etc. and are valued in terms of US Dollars. As per the RBI report, “the variations in the Foreign Currency Assets (FCA) occur mainly on account of purchase and sale of foreign exchange by the RBI, income arising out of the deployment of the foreign exchange reserves, external aid receipts of the Central Government and changes on account of revaluation of the assets”.

Apart from FCA, the other three components of FOREX are Gold, SDR (Special Drawing Rights), and RTP (Reserve Tranche Position) in the International Monetary Fund (IMF). FCA constitutes 93 per cent of total FOREX, while gold is 6 per cent, SDR is 0.32 per cent and the Reserve position in IMF is 0.80 percent, as on December 20, 2019.
The demands on the foreign exchange reserves is determined by the size of external sector to GDP ratio, the degree of openness of the economy and the liquidity requirements. The essential legal framework for reserve management is RBI Act of 1934. In order to understand the variations in sources to FOREX, one needs to see both current account (trade deficit) and capital account of the Balance of Payments (BoP) statement.

Capital account has two significant components– Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). Within Foreign Portfolio investment, the significant components are Foreign Investors Investment, Banking Capital including NRI deposits, Short term credit, External assistance and External Commercial Borrowings. The “Other items” (miscellaneous) in capital account’ apart from ‘Errors and Omissions’ include SDR allocations, leads and lags in exports, funds held abroad, advances received pending issue of shares under FDI and capital receipts not included elsewhere and rupee denominated debt. This recent surge in forex is due to the improvement in trade deficit (X-M), and also increase in flows to FDI and FII.

The adequacy of FOREX reserves depends on its ability to cover imports. In this fiscal year 2019-‘20, the forex reserves cover of imports has increased from 9.6 months in March 2019 to 10 months in June 2019.

Another important factor to examine is whether our booming FOREX reserve is stable or volatile. This depends on the composition of FOREX. If volatile capital flows – for instance, foreign portfolio investment and outstanding short term debt – are significantly higher components of FOREX, then the FOREX reserve is not stable. This is because foreign portfolio investment is broadly the “hot money”, and hot money by definition is responsive to interest rate differentials and flow out of the country if the interest rate of rest of the world is higher than our interest rates.

As per the recent RBI Report on FOREX Management, “the ratio of volatile capital flows (including cumulative portfolio inflows and outstanding short-term debt) to reserves declined from 88.7 per cent at end-March 2019 to 86.7 per cent at end-June 2019”.

So it is an irony in itself to find macro-economic certainty in the booming FOREX, when the world economy is in recession and there is glut in the domestic market in India. Given the global economic downturn, Prime Minister Narendra Modi has reiterated that the government would focus more on the structural reforms related to fiscal and financial sector from a long term perspective, rather than focusing just on booming FOREX reserves. As the Union Budget 2020 is around the corner, everyone is expecting measures from the government that would spur the Indian economy to turn-around.

 

Script: Dr. Lekha S Chakraborty, Professor, Nipfp

- Advertisement -spot_img
Latest news
Related news