India’s dream of becoming a global manufacturing hub in the coming future is, to be honest, a far-fetched one, especially considering the current financial and infrastructural state. Amidst fiscal demand and the contracting economy for the fourth consecutive quarter witnessed after more than a decade, foreign exchange reserves can be that one guiding light in the sustenance of the country’s dream, even though it right now remains a long one. It is because a considerable foreign exchange reserve ensures self-assurance and is a way to represent the country’s ability to pay off the debt to foreign credit rating agencies, which however is a good sign at the point especially considering the increasing fiscal expenditure by the government in an attempt to revive the crashing economy would be hard on the country’s image in front of the credit rating agencies. This is said keeping in view the fact that the government’s fiscal deficit is a representation of the government’s borrowing, which if large, creates a problem in credit accessibility internationally. However, at this point, it is crucial to undertake fiscal expenditure in order to revive the aggregate demand and thus, income levels of the economy to facilitate growth. Thus, the presence of a significant foreign exchange reserve at this point is a saving sign. However, there are certain aspects to this that need to be covered in order to ensure the sign stays a good one in the near future too.
Before talking about what the numbers are right now, let’s understand how and why these numbers come from. So, let’s go back to the first week of October 2020, when India’s foreign exchange reserves surged to a mind-numbing USD 555.1 billion as opposed to USD 474.660 at the beginning of the financial year. This can be credited mostly to the pandemic that brought a halt in demand for imports, creating a rare current account surplus, and a steady flow of portfolio inflows. Take a moment to understand what this number really implied- the level of reserves as mentioned for the first week of October were large enough to cover 12 months of the pre-pandemic level of imports, which is nearly 99 per cent of India’s external debt of USD 558.5 billion as of March 2020. Hence, the number was considered fairly adequate by most experts, some even going to the extent of claiming it more than adequate. The number further went ahead to increase to USD 584.6 billion.
Now, the thing about this reserve was that this was built on capital account surpluses as opposed to the current account surpluses, despite a rare current account surplus at the time. All this may seem to be a little confusing at the moment but let me clarify some things for you. India saw a record high current account surplus — a rarity for the economy — in the April-June quarter as a precipitous drop in local demand led to a sharper fall in imports compared to exports. The quarter also saw net portfolio and foreign direct investment (FDI) flows slow to a trickle, while remittances from foreign workers fell. This amount was in sharp contrast to negative current account surpluses in the preceding quarters, except for the one with a surplus of 0.6 per cent in the one that just came before the said quarter. Now, the thing about this current account surplus is that it was created because of the pandemic and not organically owing to increased exports, meaning that as things began to get normal, it did not sustain, as predicted by economists. Now, the deal with a large foreign exchange reserve which is created mostly on the basis of capital account surpluses, which either means foreign borrowings or sale of investments, doesn’t really contribute to the economy in the form of wealth because as mentioned, at the end of the day, it is borrowed amount. Reserves built out of current account surpluses, which basically implies that the country has been an overall net exporter, is the amount that can act as the wealth of the economy, which sadly is not the case for India.
Therefore, as global trade and domestic demand took their original course, the foreign exchange reserves for the country started to flatten out in the past months of the year 2021. However, the rate of decline for the country has been slower than countries like Russia, leading to the county overtaking Russia to claim the fourth place in the list of the world’s largest foreign exchange reserve holdings, with the number at this moment being USD 580.3 billion, a fall by USD 4.3 billion. This number right here means that the country has enough to supplement imports for the next 18 months, especially because of the increase that was witnessed in the local stock market and foreign direct investments for the country. So, even though this reserve cannot be used as wealth for the economy, it would serve as a way to reassure India’s position in terms of the credit rating numbers.
Chief India economist at Deutsche Bank, Kaushik Das said, “The healthy FX reserves position should give enough comfort to RBI for dealing with any potential external shock-driven capital-stop or outflows in the period ahead. The RBI’s recent purchase of USD 88 billion in the foreign exchange market last year added the rupee to the US watch list for currency manipulation, making the rupee the worst performer among Asia’s major currencies for the last year. This was done in an attempt to stimulate exports while discouraging imports for the country, the considerable outcome of which is yet to be seen. This called in for remarks from the RBI Governor Shaktikanta Das in the latest interaction, stressing the idea of emerging market central banks to build reserves to prevent any external shocks, irrespective of being put on watch by the US. The RBI even focused on further strengthening foreign exchange reserves.