20, June 2021
Ram Suresh
www.mediaeyenews.com
In early June India’s foreign exchange reserves topped $600 billion for the first time ever, sending a whiff of fresh air into an otherwise glum economic predicament in the country that was wracked by pandemic-induced lockdowns. Perhaps justifiably, the event has spurred chest-thumping among the chattering classes. But this is no time to rest on laurels.
The stockpile – the world’s fourth-largest, behind China, Japan and Switzerland – is no mean achievement. At $608 billion in the week ended June 11, the reserves were sufficient to pay for more than 18 months of imports, a giant leap in fortunes from the precarious situation in 1991 when the reserves had plunged to a level that could barely cover two weeks’ import bill.
Robust exchange reserves underpin a country’s economic health, act as a buffer in times of crisis and provide strength to the currency. They also uplift confidence among world businesses and authorities to engage in deals with the country, sure about receiving their payments. In other words, it is like a rich man in a city with whom everyone would love to have a formal relationship, assured about his ability to honour commitments.
So, a fat forex kitty is a matter of pride and a source of comfort. It provides elbow room to face challenging times. In the process, however, one must not lose sight of vulnerabilities that lurk beneath the surface.
Unlike major accumulators such as China, Japan and Russia whose reserves are built on large trade surpluses – export earnings far exceeding import bills, India has been perennially a trade deficit nation whose import consumption is way ahead of sales overseas. India’s exchange reserves are the result of large capital inflows in the form of foreign direct investment (FDI), foreign portfolio investment (FPI), external commercial borrowing (ECB) and remittances by non-resident Indians.
Therein lies New Delhi’s vulnerability. Currently, with many central banks worldwide on a mission of pumping cash into the system to soften the blow caused to citizens by the coronavirus pandemic, there is excessive availability of cheap funds. In this ultra-loose global liquidity scenario, money managers chase countries such as India that offer better yields.
India’s bullish longer term growth prospects have been a magnet for strong portfolio inflows as well as FDIs over the past few years, and they continue to remain a formidable factor behind the revival in such inflows despite the economic contraction in 2020/21 and the rather muted expansion seen in the current year.
Exchange reserves during the past financial year grew by $99.2 billion, according to the Reserve Bank of India. FDIs in 2020/21 totalled $52.5 billion, led by Singapore with $15.9 billion and the United States at $13.2 billion, provisional data released by the central bank showed.
Although there are no dark clouds on the horizon to cause worry as of now, the overdependence on capital inflows is troublesome because they can change direction quickly based on geopolitical developments, better growth prospects elsewhere, changes in yields, global risk appetite and so on. In 1990, for instance, even NRI deposits saw outflows in the panic-driven run-up to the first Iraq war.
Policymakers in New Delhi must pursue a hands-on approach to tackle economic twists happening all the time. They cannot afford to take their eyes off the ball. Quick decision-making is important to halt downturns and steady the ship. It is important to note that foreign capital flows are influenced by sovereign ratings, and any downgrade could trigger pull outs.
“If India’s rating drops below investment grade, no foreign lender would be willing to refinance our old loans,” economist Ajit Ranade wrote in an article in the Times of India. “Our coffers will become empty repaying loans.”
“That’s why India’s large forex stock, to the extent it has fickle flows, should not make us complacent. Unless our exports exceed imports, we will remain vulnerable.”
At end-December 2020, India’s external debt stood at $563.5 billion, which is more than 90 per cent of the exchange reserves on June 11, 2021.
