MUMBAI, Aug 9: India’s surging foreign exchange reserves, now approaching $85 billion, gives Asia’s third largest economy a safety net against external shocks and provides it with muscle to push ahead with reforms, economists say.
But the world’s second most populous nation must utilize these resources for growth-oriented investments because maintaining high levels of reserves is costly, they said.
India’s foreign exchange reserves stood at $84.7 billion on August 1, equivalent to more than a year’s imports, having risen by an average $480 million each week this year. It is just off the all time high of $84.904 billion struck a week before.
“It gives substantial room for independent policy manoeuvre and ensures that India will not really have a problem with external liquidity in the foreseeable future,” said P.K. Basu, managing director at Robust Economic Analysis, Singapore.
Analysts say that high reserves mean India can continue to liberalize capital controls and should allow it to cut tariffs without risking a run on its currency. But there are stiff costs linked with maintaining this mountain of reserves.
For one, there is the erosive impact of the dollar’s fall. Besides, bulk of the funds are invested in low-yielding US assets and the central bank has the additional task of managing the surge in domestic money market liquidity — a result of its interventionist dollar purchases.
A decade of reforms has transformed India from a foreign exchange starved economy to one with a robust external sector position. The sluggishness in advanced economies and better local interest rates have also drawn in foreign investment flows.
“One of the big benefits of the strong external sector is that it has made foreign investors more confident,” said Ajit Ranade, ABN Amro Bank’s India economist.
He said while the expected buoyancy in economic growth was drawing foreign portfolio investments, an appreciating rupee backed by huge reserves was a significant confidence-booster.
Foreign funds’ net investments in India stood at $2.7 billion in the first seven months of 2003 as against $744 million in the whole of the previous year, lured by attractive equity valuations and the prospects of a period of robust growth.
Portfolio investments, or ‘hot money’, comprise just a fifth of total reserves and analysts say that a bulk of the reserves were a result of inflows which would not reverse at short notice.
But rising reserves in a capital-deficient country suggest that not enough has been done to enable resources coming from abroad to be used by sectors that need them, economists say.
The government has made little use of the reserves, pre-paying external debt worth nearly $3 billion in February.
“Sectors such as infrastructure need huge amounts of investments,” said D. K. Pant, economists at the New Delhi-based National Council of Applied Economic Research.—Reuters