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Forex reserves: India on a growth path? - Views on News from Equitymaster
 
 
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  • Aug 7, 2003

    Forex reserves: India on a growth path?

    Close on the heels of India recording a current account surplus for the second year in succession came the news that for the first time, our country has become a creditor nation to the IMF. In short, India would lend a helping hand to countries that are experiencing a balance of payment problem. For an economy, which about a decade back was struggling to meet three weeks of import bill, the turnaround has been nothing less than dramatic.

    Sitting pretty on a huge US$ 84 bn of foreign exchange reserves, we are now in a position to easily meet 14 months of import bill. But there’s more to this huge reserve than what meets the eye. To make things clearer, lets delve a little deeper into the reason behind the growth in reserves and analyze the three major components of the rise in reserves in FY03 where reserves rose by US$ 21 bn.

    Firstly, the depreciation of the US dollar vis-à-vis other major currencies such as the Euro and the Yen has had a positive impact on the Indian forex reserves. Almost 18% of the accretion in our reserves in FY03 were accounted for by such changes in valuation. (Source: RBI).

    Owing to the recent capital market reforms in India and relatively slow growing economies like US, Europe and Japan, developing economies like India have become much sought after destination for foreign institutional investors. Also, the LIBOR rates at an all time low and rupee appreciating against the dollar, the NRI’s (non resident Indian) are taking maximum advantage of the arbitration opportunities that exist in the Indian markets. The reserves in forex held by Indian banks have swelled and have added US$ 5 bn in FY03. Owing to the above reasons, the net capital inflows for FY03 increased to US$ 14 bn and from almost 67% of the total increase in reserves.

    As far as the current account is concerned, we ran a deficit of US$ 12 bn as our imports exceeded our exports by the said number. This deficit was in the merchandise trade segment, which is nothing but physical shipment of goods. All the forex transactions that do not involve physical shipment of goods fall under the ‘invisibles’ account. These include private remittances by Indians settled abroad, travel receipts and miscellaneous receipts and payments. The miscellaneous segment includes revenues generated through software exports and other such services. In view of the large remittances and strong performance of our knowledge sector, we managed a net invisible gain of US$ 16 bn. Given this backdrop, our overall current account surplus stood at close to US$ 4 bn, accounting for 17% increase in our forex reserves.

    India has thus added close to US$ 37 billion in the last three years to its forex kitty (including the special IMD). What does this mean for a developing economy like India and where do we stand in the global scheme of things? If the reserves are any indication, India is slowly getting attention on the radar of global investors. The middle class boom and rising disposable incomes are also luring the MNC’s into making more investments. It has to be remembered that lack of growth opportunities in key markets has resulted in a shift in preference towards emerging markets (this includes India). The Indian government has also had a positive role to play, albeit slow in momentum.

    Amidst all this, there is however a caveat. As we can see from the break up of forex earnings, a major chunk of the accretion in the reserves was contributed by the capital inflows (FDI and FII). These have to be viewed with some sense of caution, as this money can be taken out of the economy at any point of time. Similar incidences have already taken place in few East Asian economies and we need to be wary of this. Although, all seems to be good, the combined fiscal deficit at 10% of GDP is also an area of concern. Unless the government accelerates measures to improve the fiscal situation, there is every possibility that India may not be able to exploit opportunities going forward.

     

     

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