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How To Productively Use India’s 400 Billion+ Foreign Exchange Reserves

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Gone are the days when India had to call on the International Monetary Fund (IMF) to avert a potential Balance of Payment (BoP) crisis. From being one a nation which would take loans from the IMF, India has moved on to become a creditor to the IMF.

Currently, India has very healthy foreign exchange reserves of over $400 billion. It is understandable for a country facing currency volatility and vagaries of climate on sectors like agriculture (which adds inflationary pressure on the economy) to keep sufficient foreign reserve. But the question is how much foreign exchange reserves does India need? The problem with it is two-fold. They come with an ‘opportunity cost’ and ‘huge maintenance cost’ because the sovereign debt instruments (mostly US treasury bills) in which RBI deploy these reserves fetch little in return. This writer tries to answer a few questions here.

How much forex reserves does India need?
What are the alternative ways to deploy the huge reserves?
How much forex reserves is sufficient for India?

The requirement of forex reserves can be analysed on a number of macroeconomic credentials such as:

1. External Debt

As per World Bank’s ‘International Debt Statistics 2017’, India continues to be among the least vulnerable countries in terms of its debt statistics.

The reasons are:

The long term-external debt was 83.2 % of India’s total external debts (till September 2016) and forex reserve provides cover for a large percentage of Indian imports.

However, the overarching amount of non-government debt which is more prone to default and dependence of nearly 55% on the US dollar can still be considered as vulnerabilities of India’s forex reserve. Therefore, the assumption here is that India’s reserves at any point shall suffice payment of 100% of its sovereign debt and all non-government short-term debts.

2. Import Cover

As of September 2016, India has 12 months of import cover (as per the RBI data) which is fair enough considering India’s creditworthiness with the IMF. India can raise a significant amount from the IMF on a short notice in the wake of a looming BoP crisis though such a situation is highly unlikely.

3. Current Account

At present India is a current account deficit (CAD) country and is expected to continue to be so in the near future. As of September 2017, India’s CAD had risen to 2.4% of the Gross Domestic Product(GDP). For the sake of calculating a safe buffer threshold to India’s admissible forex reserve, let’s take a scenario of a high CAD for India. Let the number be 7.5% of GDP  which is fairly high. Now, the assumption is that India at any point shall be ready to compensate this amount from its reserves.

It will also bear significance for India to regulate several macroeconomic credentials to circumvent a local or international economic crisis.

Some of them include:

Government External Debt

It is admissible to not raise debt in currencies such as China. At the same time, more dependence on currencies such as Yen is fine as Japan provides ‘concessional debt’.

Corporate External Debt

India’s corporate debt will undoubtedly increase manifold in the wake of its reform and ease of doing business agenda. However, the fact that it is the low levels of corporate debt that kept India safe during the 2008 economic crisis shall always guide the actions

FDI vs FPI

The East Asian economic crisis of 1997 was compounded by capital flight from volatile portfolio investors. India is also prone to such an outward capital movement, especially due to our path towards full ‘capital convertibility’.

The admissible amount of forex reserves that India maintains shall, therefore, cover each one of the above-listed items (external debt, import cover and current account) separately and also cumulatively. Therefore, the equation comes out to be

Import cover for 12 months
+

100% of all  sovereign debt and all non-government short-term debts

+

CAD of 7.5%GDP

This number came out to $616.9 billion.The calculation is given as under:

12 month import cover = $400 billion

100% sovereign debt = $104billion ($400billion covers 76.8% of total debt of which 20% is sovereign debt)

Non govt: short-term debt =$70billion (of the total short-term debt,it is assumed that 80% is non-govt because even in total debt 80 % is non-governmental)

CAD=$42.9billion (7.5% of GDP is $14.3billion)

Now, this number is based on the present macroeconomic credentials and as we follow a ‘progressive financing’ it will rise further., However, the base guidelines stipulated shall remain the same.

Alternative ways to deploy surplus Foreign Exchange Reserve

Here, I will describe three such mechanisms to productively use surplus reserves:

1. Sovereign Wealth Fund Of India (SWFOI)

It can be utilised for investments in India and abroad in multiple asset classes. This is useful to widen operations of  Public Sector Undertakings (PSUs), acquire strategic stakes in manufacturing firms that form part of India’s import basket (eg: oil assets) etc. This will significantly augment government revenues and further add up to FDI flow destined at India. Countries such as Singapore, China etc have such funds.

2. Funding For Indian Infrastructure

The ‘infrastructure deficit’ and requirement of massive amounts in Indian infrastructure is well known. Along with creating a sustainable infrastructure that aid in reducing logistic cost and help in the improvement of ‘sunrise industries’, it will fetch FDI to India in the long run.

3. Institutionalisation Of India Led Lending In The Indo-Pacific

To counter the strategic assets acquired by countries like China mainly through ‘predatory financing'(eg: Hambantota port in Sri Lanka) in the Indian Ocean region, India needs to take up many more investment needs of neighbouring countries. Institutionalization is needed in the wake of congruence in interests between India, Japan and others in the form of Quad (India, USA, Japan, Australia) and Asia -Africa growth corridor (an initiative of India and Japan) etc. This can manifest in the form of a Quad bank, Asia-Africa bank etc… in line with China-led Asian Infrastructure Investment Bank (AIIB).

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