Foreign Exchange Reserves of India

In this article we will discuss about Foreign Exchange Reserves. After reading this article you will learn about: 1. Subject-Matter of Foreign Exchange Reserves 2. RBI’s Approval for using Foreign Exchange Reserve in Infrastructure Sector.

Subject-Matter of Foreign Exchange Reserves:

Foreign exchange reserves reflects on the health and economic strength of the economy. The movement in foreign exchange reserves is the net result of all external transactions. Therefore, it provides a summary index of the state of the country’s balance of payments.

India experienced a worst position in respect of foreign exchange reserve (including gold and SDR) where it declined to US $ 3.96 billion in 1989-90.

But after the introduction of new balance of payments adjustment strategy adopted since July 1991, the foreign exchange reserve gradually increased to $ 9.2 billion at the end of 1991-92 and then to $19.2 billion in 1993-94, that showed an increase of $10.0 billion during 1992-93 to 1993-94.

Significant improvement in India’s balance of payments during 1993-94 resulted in an unprecedented build up of foreign currency assets of the Reserve Bank of India. The foreign currency assets rose from $ 6.4 billion (Rs 20,140 crore) at the end of 1992-93 to $ 15.1 billion (Rs 47,287 crore) at the end of 1993-94, i.e., an increase of $ 8.7 billion (Rs 27,147 crore) during 1993-94.

Foreign exchange reserves which include foreign currency assets of the RBI, gold and SDRs rose from $ 9.8 billion (Rs 30,745 crore) at the end of 1992-93 to $ 19.3 billion (Rs 60,420 crore) at the end of 1993-94.

The rise in foreign exchange reserves continued to be rapid in 1994-95 and reached the level of $ 25.2 billion at the end of March 1995 and the foreign currency assets reached the level of $ 20.8 billion during the same period.

Again, the total foreign exchange reserves of the country declined to US $ 21.7 billion at the end of March 1996 and further to US $ 21.6 billion at the end of May 1996. However, the same reserves rose steadily in subsequent months to reach US $ 26.4 billion at the end of March 1997 and then reached to US $ 304.20 billion at the end of March, 2014 as compared with 309.7 billion at the end of March, 2008.

The current level of total foreign exchange reserves covers 18 months of imports.

Foreign Currency Assets:

Foreign currency assets constitute the major component of foreign exchange reserves of the country. As changes in the other two components, namely, gold and SDRs are few and far between, the movements in India’s total foreign exchange reserves are mostly governed by the movements in foreign currency assets component of foreign exchange reserves.

Table 16.3 reveals the trend in foreign currency assets component of foreign exchange reserves and some critical indicators of reserve management.

Table 16.4 shows the summary of changes in foreign exchange reserve of India.

In recent years, the foreign exchange reserve of India shows an increasing trend from $ 151.6 billion in 2005-06 to $ 309.7 billion in 2007-08 and then declined to $ 252.0 billion in 2008-09 but then again increased to $ 279.1 billion in 2009-10 and 304.20 billion in 2013-14.

In 2014-15, on month basis, foreign exchange reserves of the country further increased to US $ 330.01 billion for the week ended February 06, 2015. The level of reserves provides about 18 months import cover.

Country-wise details of foreign exchange reserves show that India is fourth-largest foreign exchange reserve holder in the world after China, Japan and Russia. Table 16.5 depicts this position clearly.

Table 16.5 reveals that the foreign exchange reserves of India was $ 296.7 in December 2011 as compared with $ 3,181.1 billion of China, $ 1,326.1 billion of Japan, $ 499.5 billion of Russia and $ 352.0 billion of Brazil.

Although the current level of reserves is comfortable, there is a need for a further build up in reserves to have greater flexibility in exchange rate management, to absorb any unanticipated external stocks, to facilitate India’s move towards full capital account convertibility, and to impart confidence in the international investor community about the soundness of India’s balance of payments.

Most of the developing countries (of East Asia), barring Indonesia, hold foreign exchange reserves at levels much higher than India.

Relatively high levels of reserve management indicators in 1993-94 and 1994-95 reflect, to some extent, the stock in capacity of the economy to absorb foreign savings. During 1995-96, however the import and investments absorption capacity of the economy expanded rapidly resulting in rise of foreign currency assets of the order of US $ 4.48 billion up to January 1996.

As a result, foreign currency assets of the RBI declined to US $ 16.32 billion at the end of January 1996, which is equivalent to 5.0 months of imports and 3.8 months of Current payments.

However, it needs to be recognised that while current level of foreign exchange reserves is adequate, it is not in excess of the need of economy keeping in view the expansion of industrial sector and the resulting future need for import and investments at levels larger than in the past. Thus the country must attain some sort of restraint in its demand for imports both on POL and non POL items.

The Government has a responsibility to convince the people about the necessity of such restraint and should try to attain the desirable level of restraint effectively so as to contain the growth of imports to a desirable level. This would definitely help the country to build and maintain the foreign exchange reserves to the required level.

The sharp build-up in reserves from 1993-94 onwards, resulted from the significant improvement in the current and capital accounts of the balance of payments. It may be recalled that during 1990-91 as well, there was a considerable inflow of $ 8.4 billion on the capital account.

This was, however, more than used up to finance the huge current account deficit, resulting in a drawing down of foreign exchange reserves in 1990- 91. But from 1993-94 onwards, as the current account gap has narrowed considerably, a large capital inflows have resulted in accretion to reserves.

The nature of capital inflows has also undergone a dramatic change, the role of external assistance gradually, and that of commercial borrowing, IMF loans and non-resident deposits progressively being replaced by foreign investment inflows.

A recent RBI study shows that the major sources of record level of reserve accretion in the year 2002- 03 have been a surplus in the current account, non-debt creating capital flows and valuation gains. In-spite of the interest rate differential of 3 to 4 per cent between the rates abroad and in India there is no evidence to suggest that arbitrage through debt capital was substantial.

It is estimated that as much as two third of the reserves accretion was on account of non-debt capital flows. The current level of foreign exchange reserves is sufficient to provide to cover more 19 months import.

RBI’s Approval for using Foreign Exchange Reserve in Infrastructure Sector:

The Reserve Bank of India has given an in-principle approval to invest five billion dollars of foreign exchange reserves annually in infrastructure projects through two subsidiaries of India Infrastructure Finance Company (IIFCL).

The Finance Ministry’s note forwarded for the Economic Editor’s Conference held on Nov. 12, 2007, mentioned, “The RBI board has given in principle approval in respect of the SPV to be established to borrow funds from the RBI and lend to Indian companies implementing infrastructure projects in India or to co-finance their ECBs (external Commercial borrowings) for such projects solely for expenditure outside India.”

The RBI Board has emphasised that the overall framework needs to be consistent with legal requirements must exhibit fiscal prudence and consistency with global best practices. Deepak Parekh Committee had also made certain recommendations on this issue.

On the basis of these recommendations, Finance Minister Mr. P. Chidambaram had proposed in its Budget 2007-08 that two wholly-owned overseas subsidiaries of IIFCL be allowed to borrow funds from RBI and lend to Indian companies implementing infrastructure projects in India or to co-finance their ECBs for such projects solely for capital expenditure outside India.

As per the system proposed the loans given by RBI to the IIFCL subsidiaries would be guaranteed by the union government and the central bank would be assured of a return higher than the average rate of return on its incremental investment. Accordingly, attempt has been made to spend minimum time between IIFCL disbursing loans to infrastructure developers and the central bank releasing the amount for the purpose.