Problem of Plenty

Context:  Higher foreign exchange reserves and import cover should not result in complacency in wider policymaking.

Problems confronting Indian economy: Low output; Likely Increase in Public debt; High Inflation; Low demand; and Increased forex reserves.

Reasons for rise in forex reserve:

• Decline in import bill: Due to weaker demand and lower crude oil prices.
• Strong capital flows: Resulted in the balance of payments surplus; (Foreign portfolio investors, bought Indian stocks worth about $7 billion in November).
  • This is also because of maintenance of the near-zero interest rates by the US Federal Reserve.

Problems associated with the excess flow of foreign currency:

• Affects the inflation-targeting: Excess rupee liquidity in the market due to the intervention of RBI to absorb excess foreign currency will affect the central bank’s inflation-targeting mandate
• Increase in bond yield and cost of money: This happens if RBI absorbs excess liquidity from the system caused due to the absorption of excess foreign currency.
• Rupee appreciation: This will affect India’s external competitiveness and potentially create longer-term imbalances in the economy.
• Charges of currency manipulation on RBI: If RBI intervenes to prevent rupee appreciation.

Way Forward:

• Coordinated monetary and fiscal efforts: Government and the RBI should work on prudent policy options to deal with the situation.
• Restrict the flow of external debt capital: The stock of external commercial borrowing is over $200 billion.

Conclusion: India needs to improve its competitiveness to revive growth and exports.