Search the Internet          Tips  Sites: Finance, Investment

'RBI must use forex reserves productively'

Haseeb A Drabu

In the first four months of this fiscal, the Reserve Bank of India has added $6 billion to its forex reserves, taking the total to almost $60 billion.

This kind of monthly accretion to the reserves is unprecedented and hasn't happened even during 1993-94 when the flush of financial liberalisation measures led to foreign capital inflow of around $9 billion.

If this rise were to be fuelled by substantial surpluses in either the current account or the capital account of the balance of payments, there would have been no dispute that the mounting forex reserves are an indication of the strength and growth of the economy.

But given the macroeconomic context and the composition of the rise in the reserves, it would appear that the reserves are nothing more than a reflection of an economy which is operating below its potential capacity and one which is slack in resource use.

A closer look at the sources of growth in the forex reserves shows that the rise is not due to any development on the trade front. If anything, the trade flows imply a fall in reserves. Exports growth in the current fiscal began well but is now following last year's trend and is all but stagnating. Imports have shown a marginal increase.

This should lead to an increase in the trade deficit. The current account couldn't have been the source of the build-up in reserves because even though it is lower compared to the corresponding period last year, the balance is still negative.

However, the reserves could have gone up through inflows into the capital account, especially increases in foreign investment and banking capital inflows. These may partially account for the rise in reserves. But banking inflows are fundamentally debt-creating and so the rise in reserves through this route has a contra-implication of rising external debt. So where is the money coming in from?

One explanation is that post-September 11, 2001, the international banking community is becoming more stringent in seeking disclosures about the sources of funds. This has resulted in a big inflow into India because NRIs find it simpler and more profitable to park funds here. This, along with the accounting scams, which are breaking out the world over with alarming regularity, is a reason for the liquidity.

This explanation merits consideration for two reasons: first, the quantum of inflows has gone up after the last quarter of 2001-2002. In fact, the reserves have gone up by 36 per cent with $16 billion having been added since the last week of September 2001. This is a distinct spurt.

Interestingly, along with rise, the "errors and omissions" in the RBI's balance of payments accounts have gone up substantially. It is now estimated to be more than one-third the flows.

Some part of the "errors and omissions" is a reconciliation with the data on exports and imports given by the Directorate General of Commercial Intelligence and Statistics on account of differences in coverage, valuation and timing.

But since there has been no change in these compared to the previous years, an increase in this category can only be explained as having come about because of irregular capital flows. And these, most analysts argue, are nothing but illegal transactions. A positive "errors and omissions" amount indicates inflows and that resources are coming into the country.

What all this also shows is that even though the RBI takes great pride in the level of reserves, it is not really a deliberate policy decision on their part to have such accretions and that they can do very little to stem it. The RBI's repeated justification that such large reserves are a protection against capital flight and currency crises is correct but only to a point.

It is now a globally proven fact that high reserves are not a sufficient condition for protection against possible crises. The experience of numerous crises shows that no level of foreign exchange reserves is enough to ward off a determined speculative capital attack. Most of the countries that have experienced currency crises over the past decade had comfortable levels of reserves.

And yet these proved to be totally inadequate to deal with the crisis. These reserves can at best be used, as the RBI has been doing, to dampen the destabilising movements of capital and volatility in exchange rate.

While it would appear that the RBI cannot help the rapid accumulation of reserves, what they can certainly do is to use them more productively. One way would be to use these foreign currency assets to allow some productive agents of the economy, like the corporates, to aggressively restructure their expensive foreign debt.

Or utilise these assets by liberalising the norms for overseas investments by companies. With the interest rates much lower than what they were when the debt was contracted, there is enough scope to restructure some part of the $30 billion commercial debt.

ALSO READ:
More Specials
More Money Headlines