An unreliable emergency fund | The Indian Express

Indian forex reserves have crossed an unprecedented mark — over half trillion US dollars, placing India only behind China and Japan in Asia. And while this may seem like a ray of hope amidst the economic turmoil in the country, one must scrutinise its utility. The issue is not about a “few extra” reserves but unused “excessive” reserves, which may indicate that the Indian government is likely anticipating the need of an enormous economic stimulus and hence, is banking on these reserves to support the failing Indian economy. If so, over-reliance on forex reserves to provide this stimulus may be dangerous and merely keeping reserves parked now is an opportunity lost.

The recent forex reserves surge was a result of two things: A spike in foreign institutional investments and savings in India’s import bill. Foreign institutional investors reinvested in the Indian market in May-June after they exited their positions in panic in March. On the other side, a global fall in fuel prices has reduced India’s oil import bill, allowing it to save up forex reserves. But why does India keep huge forex reserves despite the government’s claim that the “fundamentals” of the economy are strong?

Sufficiency of forex reserves is sometimes measured on how many months’ worth of imports a country can afford. While six months is considered sufficient, the RBI in December 2019 said it had enough to sustain for 10 months (the forex reserves were then $0.4 trillion). Today, the cover is 12 months! This is despite having a sufficient credit line from the IMF, should there be a credit shock. It is understandable for oil-rich countries to maintain high forex reserves — a single oil trade hiccup can derail their economy. Economists have theorised that holding high forex reserves is unnecessary — in fact, not using them to finance mega infrastructure projects are lost opportunities — and yet the Indian government has held these reserves in liquid, possibly for its feared D-day.

Has the Indian government been anticipating an economic hiccup strong enough to derail the Indian economy for some time now? Indeed, excess forex reserves are likely the government’s contingency fund, in case the economy suddenly topples. The pandemic has increased the government’s insecurity. Another possibility is that the government is accumulating these reserves as “Plan-B” savings should its strategic disinvestment plans fail. Third, forex reserves are also likely a way for India now to maintain its global rating after multiple reductions in its GDP growth estimates.

Last but not least, the fundamental use of India’s foreign exchange should be to ensure…