The abundant liquidity of the global financial system has prompted foreign investors to explore options for investing in India. Due to the increase in stock market inflows and FDI investments, India’s foreign exchange reserves have soared to over $ 600 billion. Is it comfortable enough?
The components of foreign exchange reserves
Foreign exchange reserves are assets held by the central bank and include currencies, bonds, bank deposits, gold, special drawing rights and financial assets. Foreign currencies, constituting the largest of India’s foreign exchange reserves, are held in the form of Treasury bonds and institutional bonds. Foreign exchange reserves are net of inflows and outflows from a country’s current account and capital account, and need not necessarily reflect the country’s positive income. With the trade of exporters and importers, remittances and FII / FDI investments in foreign currency in and out, foreign currency is accumulated with the central bank.
The importance of foreign exchange reserves
Foreign exchange reserves reflect the stability and strength of an economy’s fundamentals. When the RBI maintains adequate foreign exchange reserves, other countries are confident in its monetary and exchange management policies. It indicates a country’s ability to pay for imports, especially essential inputs such as crude oil and capital goods. By maintaining liquidity in the form of currencies, it minimizes external vulnerability to crisis situations and helps absorb shocks. In 1991, when India’s foreign exchange reserves were barely sufficient to cover three weeks of essential imports, it had to borrow from the IMF
Where is the country now?
With foreign exchange reserves reaching $ 608 billion as of June 11, India has now overtaken Russia ($ 604.8 billion) to rank fourth. The top three are China ($ 3.4 trillion in May), Japan and Switzerland. In May, India’s foreign exchange reserves stood at $ 598 billion. India is now followed by countries like Russia, Taiwan, Hong Kong and South Korea.
How did the trip to India go?
It has been a long journey, and one that has seen India strengthen its economic fundamentals. In 1991, India’s foreign exchange reserves stood at only $ 1.2 billion. Today, RBI’s position is relatively more comfortable, with sufficient foreign exchange reserves to cover 15 months of imports. A fundamentally strong reserves position gives foreign investors and rating agencies great confidence in the ability of the government to honor its debts and in the ability of the central bank to shield the economy from the drawbacks of any external shocks.
What does the existing scenario indicate?
Despite a recession, a substantial drop in exports during FY21 and the poor economic performance of export destinations, the increase in foreign exchange reserves testifies to the confidence of foreign investors in the Indian economy. A substantial increase in foreign investment has been the main factor behind the recent increase in foreign exchange reserves. Importers don’t need to be nervous about the critical import requirements needed to jumpstart the economy.
Jagadish Shettigar and Pooja Misra are faculty members of BIMTECH
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