The Financial Literacy Cell
India’s Forex Reserves touch an all time high
India’s foreign exchange reserves witnessed a spike and crossed the $600 billion mark for the first time as on June 4 the reserves kitty rose by $6.824 billion to reach a mark of $605.008 billion as per the data from the Reserve Bank of India. India almost stood tied with Russia as the fourth largest holder of Forex in the world as the nation’s central bank continues to cache dollars to cushion the economy against any sudden outflows.
To let the news sink in properly we must know what significance does the foreign exchange reserves hold in the functioning of an economy in the first place. ‘Forex Reserves’ is an important term in economics and its importance is necessary to understand how an economy functions with respect to international trade and commerce.
Essentially it refers to the assets held by a central bank in form of foreign currencies like US Dollar, British Pound, the Euro, the Chinese Yuan or the Japanese Yen as well.
In a conservative view Forex should contain foreign banknotes, treasury bills and foreign bank deposits and long & short term foreign government securities, however in practice it also contains gold reserves, IMF reserve positions, international reserves etc. These assets serve various purposes but most importantly they ensure that a central government agency has backup funds if their national currency rapidly devalues or becomes all together insolvent.
Why hold Forex reserves?
Technically it is possible to consider three major motives for holding Forex reserves these include transaction, speculative and precautionary motives for holding reserves. International trade gives rise to flow of currencies which are assumed to be handled by private banks that are driven by the transaction motive. On the other hand speculative motive is left to individuals and corporate while precautionary motives for holding Forex, like demand for money, can be related to wealth & cost of covering unplanned deficit. Looking at the policy perspective, it is clear that the country benefits through economies of scale by pooling the transaction reserves at the same time catering to the precautionary motive of keeping official reserves as a ‘war chest’.
Journey from $5 to $600 billion of Forex reserves-
India has witnessed a really interesting journey of various ups and downs while chronicling its foreign exchange reserves. While looking at India’s Forex reserves journey, the 1991 balance of payment crisis certainly marks as a major beginning point; the year when India’s Forex reserves stood at only $5.8 billion dollars and even fell further thereby inducing the country to ship out its gold to avoid a default. The crises then eventually also lead to the liberalisation of the Indian economy. As a result of these reforms a substantial increase in the reserves could be witnessed, as by 1997 India held about $29.3 billion of reserves as per the RBI report of that year. However that year was hit by the Asian Financial Crisis and this came as the first test of India’s external sector since liberalisation. The volatility in the foreign market at that time forced large spot Forex operations from the Reserve Bank in order to restore orderly conditions. After several other local challenges, in May 1998 India saw the Pokhran nuclear tests thus economic sanctions on India followed, this led to the launch of the ‘Resurgent India bonds’ which resulted in a rise of the Forex assets of $3.5 billion, as per the central bank’s report of that year.
The new century began on decent note for India as of March 2000 India’s Forex reserves stood at about $37 billion; reserves were still considered modest according to some metrics. However after all that, vulnerabilities in the Indian economy started to rise once again in the aftermath of the global financial crisis of 2008, due to which India once again found itself in a position where the adequacy of its reserves came into the question. To overcome the setbacks the government a special swap scheme to draw in foreign currency non-resident deposits which brought a certain relief to the situation and with some other initiatives yet another external crisis was passed.
Today standing with around $600 billion, adequacy of reserves does not appear to be a matter of concern for Indian economy at this stage, yet a rethink on the issue of judging reserve adequacy is underway at the central bank.
Significance and reasons behind the climb-
With the Forex reserves increase in recent times new bars are being set, the current level of Forex reserves stand enough to cover nearly 16 months of the imports, according to Shantikanta Das, the central bank has enough resources to face the challenges that may arise out of global spoilers referring to any sudden policy changes in US or geopolitical shifts that could lead to funds exiting India.
This rise has accumulated through several stages and by many factors over last few months. Many attribute the rise in Forex inflows as a result of foreign portfolio investment and foreign direct investment and also due to the decline in import bill over few months on account of dip in crude prices and trade impact following Covid 19 pandemic. Also the pile up of Forex reserves comes as an outcome of the RBI’s strategy of buying dollars when there is a sudden spurt of inflows causing volatility in the Forex market. Not just that it also sold dollars when the rupee came under pressure. In February and March the central bank had depleted it stockpile by almost $10 billion by selling dollars. Somewhere foreign fund buying of shares and debt in India can also be seen to add to the reserves.
Celebrations while keeping in mind few aspects-
Even though the heap of dollars gives the nation a macroeconomic stability, we still remain an import dependent country when to comes to crude oil, steel and various other materials thus on one side it gives ray of positivity in present tough times for the economy however on the other side it also has its share of downside as well.
Unlike the major dollar hoarding central banks of china, Russia, Saudi Arabia and japan we aren’t an export surplus nation that is we tend to import more than what we export then also we have managed to have large Forex reserves largely on the back of FDIs and FPIs. Beyond FPI &FDI inflows in the stock market are loans, these are called external commercial borrowings. The total outstanding foreign loans are $560 billion or about 93% of our Forex reserves thus becoming a downside. Another thing is that the stock market inflows especially FPIs can be easily and abruptly make an about turn. Even though not every easy but some investors who tend to be nervous or fickle can pull out funds at the drop of a hat. Even the NRIs can withdraw large dollar deposits suddenly how they did in 1990 due to the panic before the first Iraq war. Also if India’s rating drops below investment grade no foreign lender would be willing to refinance our old loans, that’s why India’s large Forex stock to the extent it has fickle flows should not make us complacent. Adding to the above points this large dollar pile manages to earn very little interest, thus all in all even though the record breaking numbers of Forex reserves come as a sort of relief in considering the present situation of the economy, still we shouldn’t get complacent about this little achievement when a whole bigger challenge of reviving the economy from negative growth rate still looms.
By - Srishti Kalakoti