India's surging Forex Reserves
Boon or Bane
 

 Article by -  Abdul Khader , Faculty Associate and
Sanjib Dutta , Faculty Member ,
ICMR Case Studies and Management Resources.

continued :The importance of managing Forex Reserves

Costs and Benefits

The costs and benefits of holding huge reserves are assessed constantly. Holding sufficient reserves prevent a country from external shocks. Though excess foreign exchange reserves prevent a country from external shocks, it involves an opportunity cost as well. The resources that have been used to purchase reserves could have been used to increase the domestic productivity.

The foreign exchange reserves can be used to acquire new technologies. This would scale up the productivity of the industry. The government can even consider raising the ceiling on the amount that can be used by Indian companies to takeover or acquire a company across the world. This would help in creation and expansion of Indian multinational companies.

According to many analysts, though the growth of foreign exchange reserves is good, but the composition of the reserves is a matter of concern. In the first half of 2002, the inflows have grown by $11.5 and in the second half the total reserves increased by $12.3 billion. RBI was candid in admitting that these reserves were a result of current account transactions. These transactions were a result of the software exports and remittances from abroad. These transactions were considered to be better than portfolio investment and NRI deposits because in the case of any eventuality, the outflow of funds in the case of portfolio investment and NRI deposit would be faster.

The growth pattern of foreign exchange reserves in 2003 has shown a different composition. The first six months of 2003 witnessed heavy inflows from NRIs. Around 42 percent of the total inflows during this period was from NRIs. The growth pattern continued in the period between April and June 2003. Of the $6.6 billion received during that period, $3.63 billion was because of NRI deposits.

The appropriate level

It is difficult to quantify the appropriate level of reserves of foreign exchange for a country. Economists have come out with some models or methods by which the reserve adequacy can be assessed. There are certain parameters which help in assessing the adequacy of foreign exchange reserves. The usual parameters are adequacy of foreign exchange reserves to take care of the future imports and whether reserves are enough to meet sudden withdrawals.

Many economists and analysts feel that the foreign exchange reserves of India are in surplus. Though RBI keeps justifying the accumulation of reserves saying that this can be used as a shield to protect the economy from capital flight and currency crises, but some economists do not buy this theory
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In the past, it has been seen that countries sitting comfortably on high foreign exchange reserves, faced worst economic crisis. Thus one can say that no levels of foreign exchange reserves are enough to protect an economy from speculative capital attack.

The high reserves can be used to smoothen the destabilizing movements. This can also be used as a shield to counter the currency fluctuations. Though, it is difficult for RBI to control the foreign exchange reserves accumulations, it can use these reserves for some productive purposes. Corporates can aggressively restructure their expensive foreign debt. Government can also use them for repaying the high cost debts from various institutions.