India-A 3rd Biggest Economy With Flourishing Forex Reserves

India-A 3rd Biggest Economy With Flourishing Forex Reserves

—A Guest Article by S. K. B. Singh @

According to data released by RBI for week ended November 6, 2020, India’s Foreign Exchange Reserves, witnessed a massive weekly surge of $7.78bn reaching at $568.49bn. The now position of India’s forex reserves is more than its external debt of $ 558.5bn.This way India’s rank in countries on the basis of forex reserve moved up to third biggest after China and Japan surpassing Russia and South Korea. India’s increasing foreign exchange reserves is a sign of International business confidence and indication of its growth potentials.

Foreign exchange reserves mainly consist of Foreign Currency Assets (FCA) in the forms of US Government bonds and institutional bonds, Gold reserves and Special Drawing Rights (SDRs) with IMF.  FCA expressed in dollar terms, which is a major component of overall reserves as at week ended 6^th November, 2020 rose to $524.74bn. At the same time, the gold reserves were valued at $37.59bn, whereas the value of SDRs with IMF stood at $6.16bn (comprising of SDRs to tune of $1.49bn and country’s reserve position with IMF to the level of $4.67bn).

India’s foreign exchange reserves witnessed remarkable journey from crisis period of 1991, when we were on the brink of default on repayment of foreign debt and had to pledge our gold reserves to raise foreign currency. Further, more recently during post Global Financial Crisis (GFC) India was one of the “Fragile Five” countries those suffered most and at that time (2012) Indian foreign reserves at $259bn were just sufficient to fund imports only of 7 months. It took nearly 8 years to reach more than double the level of foreign reserves ($568.49bn) which can now fund 14 months’ imports or repay 24 months’ of external debt with residual maturity up to 1 year. The ratio of foreign exchange reserves to external debt rose to 102%, which was 85.5% as at March 2020 and 76% as at March 2019 (incidentally the same ratio at the time of crisis year 1991 was at just 7%).

For an emerging market like India, improvement in foreign exchange reserves is crucial in financing of essential imports like crude oil and other raw materials and intermediate products that drive the productive sectors of economy, which provide livelihood to vast section of society. It is a reflection of global sentiment that increasingly believes in India’s growth story.

A large reserve of foreign exchange is strength as well as a source of stability and international confidence. This enhances the ability of country to meet its external obligations thus lowering “country specific” risk, provides confidence to international merchants/ investors about protection of their dues, stability in value of rupee against dollar / other currencies and maintain liquidity in case of economic crisis.  In nutshell, reasonably high reserves of a country indicate about its strength from angle of its ability to pay for imports or service international debt.

The sources of foreign exchange reserves of a country are flow of current account and capital account. The current account is difference of value of exports from and imports in the country. It can be surplus if value of exports is greater than value of imports and deficit if value of imports is more than value of exports. India have Current Account Deficit (CAD) which has averaged 1.4% of GDP over the last five years and remained financed by international capital flow i.e. capital account transactions. However, due to compressed imports during lockdown period of first quarter of April to June 2020 India recorded Current Account Surplus of $ 19.8 bn, which is 3.9% of GDP (with economic activities picking up during post lockdown period, this position is not likely to be sustainable and India is likely to witness CAD in medium to long run period).  On the other hand, capital account transactions are those which change the assets or liability position of foreign entities in India and comprises of Foreign Direct Investment (FDI), Foreign Portfolio Investment (FPI) by individuals or Foreign Institutional Investors, Issuing of American Depository Receipts (ADRs) or Global Depository Receipts (GDRs) by Indian listed companies, External Commercial Borrowings (ECBs), inward remittances by NRIs, short – term trade credit in shape of either suppliers’ credit or buyer’s credit and external assistance.

According to world Investment Report 2020 released by UN Conference on Trade & Development (UNCTAD) India attracted FDI inflow worth $ 51bn during 2019 as against $ 42bn during 2018.  FPI investors have been net sellers for two straight years to FY 2019-20. FPI is often referred to as “hot money” because of its tendency to flee at the first signs of trouble in an economy or improvement in investment attractiveness elsewhere in the world. On the other hand, for emerging economies like India, enlarged FDI is welcome as it provides much needed capital support for enhancing the production capacity, which in turn will help in more employment generation, income and demand in the economy besides access to improved technology.

India should take advantage of its strength in foreign reserve position in attracting more FDI. With growing skepticism about China, MNCs are likely adoption of new strategy on location of manufacturing and services units on “China plus One” basis where India can be such “One” destination. At the same time, India also needs to upgrade its own manufacturing capabilities at internationally competitive prices and quality levels to maintain competiveness in its exports.

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K B Singh is a former Deputy Zonal Manager,of Punjab National Bank and can be reached at kb.singh1601@gmail.com

* The Views expressed are solely of author only .