Need to bolster our reserves

Need to bolster our reserves

FPJ BureauUpdated: Saturday, June 01, 2019, 10:25 AM IST
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Now that the hurly-burly over NDA’s first budget is over, India’s finance minister and the Reserve Bank of India need to address the persistent vulnerability in India’s transactions with the rest of the world. True, there are encouraging signs that exports are growing slightly faster than imports. Foreign exchange reserves are also fast closing in on the record level of $321 billion three years ago. But are these reserves adequate to cover our burgeoning external debt obligations, a significant part of which has to be repaid in a year’s time? Are they enough to take care of an outflow of foreign portfolio investments, if there is a sudden change in sentiment?

“We have a lot of reserves. Right now, $300 billion plus. So the key question is at what point do you feel safe?” asked RBI’s Governor Raghuram Rajan.  “I think if you focus only on reserves, there is really no point at which you feel safe, because provided there is enough uncertainty about the economy, uncertainty about conditions, uncertainty about the treatment of international investors, 400, 500, 600 any level of reserves, until you get to Chinese levels, is probably not enough,” he said, in a conference call with researchers and analysts after the second bi-monthly monetary policy review in early April 2014.

The latest Economic Survey for 2013-14, too, alluded to the vulnerability on the external front by noting that investment income outflows  – most of it to repay debt and repatriate profits and dividends – have been “growing at a fast clip.” Put simply, what the survey was stating was that India was, of late, increasingly borrowing to finance the growing gap between exports and imports of goods and services. This was perhaps necessitated by lower inflows of foreign direct and portfolio investments, due to the uncertain economic environment then in India. However, such borrowings have to be repaid. Investment income outflows constituted a whopping 71 per cent of this much lower imbalance in 2013-14.

India has borrowed heavily from the non-resident Indian community by putting in place a one-time special swap window for foreign–currency non-resident deposits and banks’ overseas borrowings, through which $34 billion was mobilised. NRIs were offered higher dollar rates of interest and naturally stepped up their deposits. Although this bolstered our foreign exchange reserves considerably and averted downward pressure on the exchange rate of the rupee, the fact is that these have to be serviced and honoured in full. All of this naturally adds to India’s sizeable external debt burden, especially of a shorter duration.

This short-term debt burden was as high as $175 billion in end-March 2014, or two-fifths of the India’s external debt of $440 billion. One-thirds of this amount that has to be paid within a year is on account of NRI deposits alone, with external commercial borrowings being next in order of importance. Coming back to the question of adequacy of our foreign exchange reserves, short-term debt with a residual maturity of a year takes care of three-fifths of it!

Besides short-term debt, sharp swings in capital flows are also a contingency that must be kept in mind in judging whether or not our reserves are adequate. This was highlighted by the SS Tarapore committee on capital account convertibility way back in 1997. One precondition was that cumulative portfolio investment inflows and short-term debt must not be more than 60 per cent of our foreign exchange reserves. In other words, our forex reserves must be plentiful – in fact, with a margin to spare — to take care of heightened volatility in capital flows in and out of the Indian economy and to meet our most pressing debt obligations without defaulting!

By that precondition, there is certainly no going back to the 1990-91 era, when the ratio of portfolio investments and short-term debt or volatile capital flows to foreign exchange reserves was a whopping 146.6 per cent in end-March 1991, which forced India to approach the IMF for assistance and launch economic reforms. A decade later, it was down to 58.5 per cent.

The vulnerability was perhaps the greatest when it deteriorated from 94 per cent in end-March 2013, to 97.3 per cent in end-September 2013. Matters have hardly improved of late, as this indicator of reserves adequacy in end-March 2014 is still a whopping 93 per cent. In other words, our reserves can just about barely cover the adverse contingency of portfolio investors exiting from the market and meeting our immediate debt obligations.

Clearly, India must build up more reserves. Policy makers can do this by encouraging export growth and reducing import-dependence. More reserves will flow in when foreign investors acquire greater confidence to invest in the country. This calls for improvements in the business environment and a stable, transparent tax regime. All of this will obviate the need to borrow abroad and will lower short-term debt.  This will reduce the vulnerability in our external accounts that is a clear and present danger to the Indian economy.

(N Chandra Mohan is an economics and business commentator based in New Delhi)

 N Chandra Mohan

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