Opinion - Editorials

Where reserves matter

THE SIZE OF India's external reserves crossed $60 billion recently, according to the RBI's report. Impressive as it sounds, it ought to be seen as much more than a statistical milestone. Its true significance lies in understanding the factors that have taken the country's external account to a position of relative strength. The management of the external sector has been a bright spot in the overall macroeconomic management. The burgeoning reserves are one highly visible facet. The fact that there has much less volatility in the forex markets recently compared to other countries is another favourable consequence. Significantly, foreign exchange reserves have been accumulating even when the external environment has not been wholly conducive. Last year (2001-02), especially, was not a good one for forex inflows into developing countries. Yet, reserves grew by as much as $11. 8 billion, the highest increase recorded in any one year. As the RBI credit policy records with satisfaction, in the four years since the East Asian crisis of 1997-98 the forex reserves have more than doubled. Those indicate quite strongly the domestic as well as international confidence in India's balance of payments since 1990-91. More recently, the steady accumulation has been attributed to healthy forex capital and portfolio inflows which the RBI has been mopping up and hence adding to the reserves. Excess dollar liquidity would cause the rupee to appreciate, thereby harming the export effort, which only recently has been gathering steam. However, all the positive factors notwithstanding, it has been realised that the accumulation of reserves is partly due to lower oil and other imports reflecting a recessionary economy over the past two years. In that context, the expected surplus in the current account (for the first time in more than a decade) ought not to be viewed as being wholly positive.

It is evident that all the yardsticks used to measure the external economy are relative. Whether the current level of reserves is adequate for the macro economy or not is an issue that is being debated at length by central bankers. While there has been no unanimity, it has been realised that an entirely new approach has to be adopted: reserves management should not only take note of identifiable factors — the size of the current account, the quantum of short-term liabilities, the variability of portfolio flows and the liquidity risks associated with every type of forex inflow — but also reckon with unanticipated pressures due to external shocks. Further, for India the size of the oil import bill cannot be accurately estimated even for the next few months. Indian stock markets with their current low valuations are attractive for overseas investors. It is likely that the favourable weights given to India and Indian stocks can be altered very quickly for any number of reasons. Many of those are outside the Indian policy framework.

The above suggests that the prudent approach now being pursued in utilising the forex holdings is in order. In the recent past, considerable relaxations in the current account have been announced. As for capital account, 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. All these are the direct outcome of the growing confidence not just in the present size of reserves but in the management of the external economy.

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