No Merit In Holding Huge Forex Reserves

India’s forex reserves have not enhanced rupee stability. Lower level of reserves, allowing for a two-way fluctuation, will help

- TB Kapali

India’s foreign exchange (FX) reserves — foreign currency assets (FCAs), to be precise — continue to rise inexorably. In the last 12 months, they rose around $60 billion to touch the current level of $460-470 billion. In the past six years, they have zoomed $150 billion. In comparison, FCAs were at $30 billion in March 2000.

In addition, if the investment intentions of large global players such as Amazon are any indication, it is almost certain the country’s FCAs will continue to rise strongly — provided there is no change in India’s policy (implemented through the Reserve Bank of India) of absorbing incoming foreign flows of capital (equity and debt) into the country’s FX reserves.

Let’s explore in-depth the above-said policy of absorbing foreign capital inflows into FX reserves. The purpose that the policy says its seeks to serve is the maintenance of external sector stability as well as of the country’s ability to pay for critical imports when external financing arrangements are constrained. As is well known, people say almost axiomatically that our FX reserves are equivalent to “so many months of imports”, the implication being that if other financing sources dry up, India can still carry on.

Indeed, India now figures among the top global holders of FX reserves, within a larger set of Asian countries — viz China, Japan, South Korea, Taiwan, Singapore, Hong Kong, Saudi Arabia — that dominate global FX reserve holdings.

A crucial difference, though, is that the reserves of the above Asian countries also comprise a significant component of export surpluses in addition to capital flows.