Aug 18, 2003|
Rising Reserves: Dilemma of a different kind
Ever since our forex reserves have started reaching unprecedented levels (US$ 84 bn at the last count), the policymakers have been confronted with a dilemma of a different kind. How to cope up with this embarrassment of riches? A lot of people have started arguing that rather than allowing the reserve to idle away in low interest earning dollar deposits, it would be prudent to use those reserves in a manner that would help in the overall development of the economy. Therefore what should be the ideal level of reserves (to withstand shocks such as the rise in oil prices or of sudden capital flight), and what part of the reserves should be put to proper use. Let’s find out.
Developing nations should have adequate reserves. Earlier, the norm was to keep the reserves at levels such that it should be possible for the country to meet its import bill for a certain number of months. But things are different today. A radical transformation has taken place in the capital market in recent years. In addition to trade deficits and economic growth (two major indicators of exchange rate movements), capital flows have also emerged as one of the indicators of exchange rate movements and these capital flows are potentially more dangerous than the other two. This is because it is short term in nature and more susceptible to mass speculation than the other two. Therefore, it is being increasingly felt that in addition to meeting import bills for a certain number of months, the reserves should be sufficient to cover likely variations in capital flows or the liquidity at risk.
The capital flows of the type mentioned above, are mainly directed at a country’s capital markets and are non permanent in nature and hence can be taken out from the markets at a very short notice. The permanent capital investment on the other hand, reflects the confidence of the investors in the long-term growth prospects of the country. These investments not only add to the forex reserves but it also obviates the need for imports, as the goods are available in the local markets. But for all this to take place, the government has to create a proper climate and make substantial investments towards improving the overall infrastructure of the country. This is where the reserves can be put to use. The government can use a part of these reserves to improve the basic infrastructure such as roads, ports, and electricity so that the overseas investors find India an attractive destination to invest.
The comfortable position of India’s forex reserves is making a lot of people to proclaim that the capital account convertibility process should be hastened. Capital account convertibility is nothing but giving someone an unrestricted freedom to convert his assets from one currency to another. Although full convertibility of the rupee is some distance away, there has been notable progress. Companies have been allowed to retire overseas debt ahead of schedule. They have considerably more leeway in acquiring foreign companies. Banks in India have been asked to confer convertibility status on a significant portion of their non-resident deposits. Very recently, fungibility of shares listed in Indian stock markets has become a reality.
A non-resident shareholder can easily shift his investments between instruments listed in India and the underlying ADR/GDR listed abroad. Thus it would be fair to say that as far as conveniences on the personal and business front is concerned, rupee is for all practical purposes convertible. However, there should be restriction on short term external commercial borrowings and also on the freedom given to domestic residents to convert their domestic bank deposits and idle assets in response to market developments as these can make an economy extremely vulnerable and no emerging market can cope with such contingencies.
Despite these avenues, the government seems to be gripped by a fear psychosis created due to the balance of payments crisis of 1991. However things are different today and the current reserves are unlikely to dwindle significantly in the near future as the economy is looking fundamentally more stronger today than it ever was. Therefore, the government will have to move away from the conservative policy framework, which it has been adopting for quite some time now, so that the full benefits of reserves are realized.
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