An unreliable emergency fund

Context: Over-reliance on forex reserves is problematic, not using them is a lost opportunity.

Reasons for the recent rise in Indian Forex Reserves: crossed half trillion US dollars, placing India only behind China and Japan in Asia. This is because of:

• Spike in Foreign Institutional Investments (FII)
• Savings in import bill due to falling crude oil prices.

The Utility of forex reserves: 

• Safeguarding in imports during a crisis: forex reserve can cover 12 months of imports, which is well above the recommended 6 months.
• Acts as a contingency fund in economic crisis: helpful in times of increased government’s insecurity.
• Plan ‘B’ Savings, should the strategic disinvestment plans of the government fail.
• Sustains global rating: after multiple reductions in India’s GDP growth estimates.
• Ensuring currency stability: with respect to that of dollars through monetary policy.

Forex reserves as lost opportunities: Due to overreliance on forex reserve to provide stimulus.

• A false fear of D-Day: In the fear of the current crisis, the reserve is not being utilized.

• The call for Self-reliance has negatively impacted its use for financing imports.
• It cannot be used to bid INR against other currencies since investors will not hold INR.
• This also restricts their usage in mega infrastructure projects.

• Not being used for stabilizing currency as the INR remained cheap during the last few years owing to RBI supporting its balance sheet and enabling transfer to government as dividends.
• Highly Volatile Nature: FII in India fell by Rs 65,000 crore in March due to Covid-19 and rose back in May 2020 restoring the forex reserves.

Way Forward: Ensure stable forex reserve, so that it does not shrink just when they are most needed.