India's Surging Forex Reserves Boon or Bane

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Authors: Abdul Khader, Sanjib Datta,
Faculty Associate, Faculty Member
ICMR (IBS Center for Management Research).

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The Indian Context

In the Indian context, the RBI Act and the Foreign Exchange Management Act, 1999 set the legal provisions for governing the foreign exchange reserves. RBI acts as the chief monetary authority and the custodian of foreign exchange assets. RBI accumulates foreign currency reserves by purchasing from authorized dealers in the open market operations. Another source of Foreign exchange for RBI is deployment of foreign exchange reserves in appropriate instruments of select currencies. The type of instruments in which RBI can invest is stipulated in the RBI Act. The aid received by the government also becomes a part of the reserves.

The outflow of funds results from the sale of foreign currency to the authorized dealers through open market operations. The resultant effect of the sale and purchase of foreign currency determines the level of foreign exchange reserves in a country.

The Surge in the Forex Reserves

The Asian crisis tells us how countries suffer due to ill management of the foreign exchange reserves. Many countries foresaw the vulnerability to the external shocks and accumulated heavy foreign exchange reserves. Countries want to keep their exports competitive. Hence, they prefer to depreciate their currencies against dollars. In recent days, there has been a continuous appreciation of rupee vis-a-vis dollar. To avoid the appreciation of rupee, RBI has been continuously interfering in the money market. RBI is buying dollars from the market. The dollars that are being bought add to the foreign exchange kitty.

Unlike, in the past, the NRI community is more dispersed now, not just confining to the Gulf. Due to software boom, Indians are heading towards new destinations. NRIs are doing well there and ploughing back their savings to India. Moreover, foreign institutional investors are also making huge investments into Indian stocks.

The emergence of India as an offshore outsourcing hub has created new opportunities. There are huge dollar earnings for India. Further, India is also proving to be a worthy manufacturing hub for many companies. All these factors played a positive role in building up of huge foreign exchange reserves.

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