The Reserve Bank on Monday warned that India's foreign exchange reserves mostly comprise borrowed funds and the country is vulnerable to sudden outflow of funds.
"Our reserves comprise essentially borrowed resources, and we are therefore more vulnerable to sudden stops and reversals, as compared with countries with current account surpluses," RBI Governor D Subbarao said at the Special Governors' Meeting in Kyoto, Japan.
India's foreign exchange reserves increased by $1.97 billion to $ 299.39 billion for the week ended January 21. The forex reserves were $297.41 billion in the previous week ending January 14.
He further said that India's forex reserves are a result of capital inflows in excess of its economy's absorptive capacity.
He added that among the components of capital flows, India prefer long-term flows to short-term flows and non-debt flows to debt flows.
"India has experienced both 'floods' and 'sudden stops' of capital flows. India has followed a consistent policy on allowing capital inflows in general and on capital account management in particular," Subbarao said.
FDI has dipped 26 per cent during January-November 2010 to about $ 19 billion from $ 25.5 billion in the year-ago period.
During 2010, FIIs whose investments have often been called 'hot money' because they can be pulled out anytime, have purchased stocks and debt securities worth Rs 9,60,000 crore (Rs 9,600 billion).
At the same time, FIIs sold shares and bonds worth Rs 7,80,000 crore (Rs 7,800 billion) during the year - still leaving behind a record net investment of over Rs 1.75 lakh crore for the year.
He further said that India should move towards capital account convertibility gradually, taking cues from domestic and global developments.
"We believe our economy should traverse towards capital convertibility along a gradual path - the path itself being recalibrated on a dynamic basis in response to domestic and global developments," Subbarao added.
Capital account convertibility is the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange. It allows anyone to freely move from local currency into foreign currency and back.
In the aftermath of financial meltdown, the RBI had adopted a cautious stance on financial reforms, including full convertibility of the local currency.
Subbarao added that RBI doesn't disclose the currency composition of the country's reserves and it has been criticised for lack of communication in this regard.
"The information is market sensitive and disclosure could potentially impact our commercial interests adversely. Disclosure also has wider implications for our international relations," Subbarao added.
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