Our Record Forex Reserves Must Be Seen In The Right Perspective

Context: The $600 billion-plus foreign exchange reserve we have is neither a big achievement nor of much economic help right now.

Reasons for rising foreign exchange reserves:

• Demand-side factors: Indian demand for foreign currency declined. This can be understood from
  • Fall in import bill: Imports of goods in 2020-21 fell to $392.2 billion from $474.2 billion in 2019-20.
  • Fall in foreign currency spending: As there is a drop in personal and business foreign travel, foreign education etc.
• Supply-side factors: Higher foreign portfolio investments, reaching an all-time high of $37 billion.
  • This is not going to prevail forever, thus limiting prospects of higher foreign exchange reserves.

Critical analysis of higher foreign exchange reserve:

• Provides lesser import cover: As per RBI’s latest State of the Economy report, the current level of reserves provides cover for less than 15 months imports, which is lower than other major reserve holders like Switzerland (39 months), Japan (22 months), Russia (20 months) and China (16 months).
• Low external debt margin: As of December 2020, total external debt stood at $563.5 billion, at 104% of foreign currency assets.
• Narrowing net international investment position: Which is the difference between a country’s stock of foreign assets vis-a-vis foreigners’ stock of country’s assets.
  • In India’s case, the net international investment position as of December 2020 was (-) $340.5 billion or (-) 12.9% of the GDP, from (-) $425.1 billion in December 2019.
  • A major reason for this has been the increase in foreign exchange reserves (get counted as assets), from $459.9 billion in December 2019 and to $585.8 billion by December 2020.
• May not be of much economic help: Borrowing against foreign exchange reserves is the last resort and is only done in times of extreme emergency like 1991.
  • Cannot be used for boosting private consumption: As RBI buys foreign currency by selling rupees, there’s no scope for printing more money from increased reserves.