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Foreign currency reserves: Too much of a good thing

Paranjoy Guha Thakurta in New Delhi

India currently faces two problems of plenty: the excessively high stocks of foodgrain in a country where malnutrition is widespread and even starvation deaths are taking place in places like Orissa.

What is not being discussed as avidly is another plentiful problem: India's record reserves of foreign currency that are proving to be an embarrassment of riches.

The Reserve Bank of India has stated that on August 24 the value of the country's foreign currency assets stood at U.S $44.6 billion, the highest ever and equivalent to the import requirements of almost one full year.

The excessively high level of the reserves can be gauged from the fact that a little more than a decade earlier, in June 1991, India's hard currency exchange reserves had plummeted to barely two weeks' import requirements.

Not everyone believes this is a problem of plenty. Union Finance Minister Yashwant Sinha for one. Replying to a debate in Parliament on Tuesday he said: "We have a problem of plenty as we are sitting on mountains of foodgrains."

He then added: "If we are to count our blessings, we have foreign exchange which is at a record level."

India's foreign currency reserves have been growing steadily in recent times. Over the last year the growth has been particularly noticeable at around $10 billion or more than one-fifth.

The main reasons for this expansion in reserves include sluggish demand for imports and the government's efforts to raise hard currency abroad.

Should the country's central bank be holding reserves equal to almost one year's imports? "There is no clear consensus on this issue," says professor B.B. Bhattacharya, who heads the New Delhi-based Institute of Economic Growth.

He points out that the US holds negligible foreign exchange reserves because of the strength of its own currency. This is also true for a country like South Africa that is a major producer of gold. On the other hand, despite holding foreign exchange stocks worth $85 billion, South Korea went through a financial crisis in 1996-97.

Bhattacharya says there are no yardsticks for what constitutes an 'adequate' level of hard currency stocks, pointing out that China's foreign exchange reserves are in the region of $150 billion while Hong Kong's reserves are one-third the amount.

Financial analyst and economist Surjit S Bhalla says: "Since the RBI is committed to 'managing' the external value of the Indian currency and since our external debt levels are nothing to worry about, by all indications the foreign currency reserves are much too high".

Why are India's hard currency reserves as high as they are? An important factor is the recent slowdown in the economy that in turn has meant lower demand for imports.

In the 12 months that ended in March, India's non-oil imports were roughly equal to the current level of reserves of $45 billion. Imports are not expected to rise significantly during the current fiscal year. If anything, there might be a slight contraction in imports in view of the sharp deceleration in industrial production.

The other reason for the high forex reserves is related to the government's recent efforts to raise funds outside the country. After the Atal Bihari Vajpayee government conducted nuclear tests in May 1998, the US and Japan imposed economic sanctions on India.

This prompted the government to issue a series of Resurgent India Bonds that raised a sum of $4.2 billion, mainly from non-resident Indians.

Then, in October 2000, the country's largest commercial bank, the State Bank of India, launched the India Millennium Deposit scheme that has garnered around $5.7 billion from NRIs and overseas corporate bodies controlled by overseas Indians. The IMD scheme was justified on the ground that India could not afford to be complacent about its foreign currency reserves, especially at a time when international prices of crude oil were rising rapidly.

World oil prices nearly trebled in 1999 and India's hard currency reserves came down by $3 billion to reach a level of $32 billion in October 2000. But many of last year's apprehensions have been proved to be unfounded.

"The IMD scheme was not necessary," says Bhattacharya. "It only provided a few sops to NRIs and enabled the finance minister to boast that he had boosted the country's foreign exchange reserves."

Bhalla, managing director of Oxus Fund Management, concurs with this viewpoint. "On hindsight, the SBI's IMD scheme was not needed as we do not require the kind of foreign exchange reserves we have at present."

In the past, high hard currency reserves have spilled over to the domestic financial system by adding to liquidity that in turn has contributed to inflationary pressures. This has not happened so far and the current inflation rate is around 5.5 per cent.

No one is "complaining about an intolerable price rise," Sinha told Parliament.

Time may be running out, however, for the finance minister. "The only solution to reducing foreign exchange reserves is to get the economy moving," says Bhalla. That is, of course, easier said than done.

Indo-Asian News Service

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