The Hindu Business Line : `$200 b forex no reason to rejoice'

Chennai April 13 "You can't eat foreign exchange! Accumulation of forex reserves is not bliss. It is a curse," says Mr K.P. Geethakrishnan, former Finance Secretary, with just a touch of acerbity, when asked to react to the news of India's forex reserves touching $200 billion.

Citing the parallel of bumper crops and reaping a huge mountain of foodgrain, and then coping with the resultant problems of storage and disposal, he said: "We are used to problems of deficit. We don't know how to handle problems of plenty."

True enough. But having a stockpile of $200 billion is a far cry from having almost nothing in 1991. Government officials and the then RBI governor, Mr S. Venkitaramanan, had to run from country to country to seek help and stave off a default in payments. Only a pledge of gold saved the country's reputation then.

The situation has changed, and the change has been slow at first and more rapid over the past few years. Reforms helped fuel increasing portfolio and direct investment over the last few years and bring more foreign money into the country.

Fiscal 2007 alone saw reserves go up by nearly $50 billion.

Let rupee firm up

While expressing delight at reaching this landmark, Mr Venkitaramanan said: "Affluence can be too hard to bear. Accumulating reserves is now only injecting more liquidity and helping fuel inflation. Maybe it is time to allow the rupee to appreciate a bit more. Accumulation of reserves is not an end in itself. There is no point in giving a return of 30 per cent to FIIs and earning only about five per cent on the investments of these reserves."

Mr Geethakrishnan advocates using a part of the forex stockpile for infrastructure projects; this will not lead to an immediate increase of consumption expenditure that would be inflationary. He also suggests letting the rupee appreciate to reflect improved fundamentals. (The rupee has appreciated about four per cent over the last year and nearly 10 per cent from its low of 47 against the dollar in July 2006.)

Mr K. Subramaniam, retired civil servant, differs on this issue.

"There is always a trade-off between the exporter and the importer. The appreciation of the rupee may not hurt IT companies much; but they will certainly affect manufacturing exports where margins are much smaller."

Volatile inflows

On the issue of forex reserves accumulation, he said: "With regard to the composition of these reserves and their volatile nature, it is a matter of concern. These are not trade flows or FDI that would be here for a longer duration. These are fairweather remittances, which will flee either in a crisis or a perception of a crisis. Given global imbalances and mobility of capital, Asian countries have to be on guard and fight the flight of capital."

Repeating an observation he had made many years earlier, RBI Governor Dr Y.V. Reddy, said at Singapore couple of months ago: "The reserve accumulation could also be seen in the context of the availability of abundant international liquidity following the easing of the monetary policy in industrial countries.

"The resultant excess liquidity flowed into the emerging markets.

"In the event of hardening of interest rates in industrialised countries, this liquidity may as quickly dry up; in that situation, emerging markets should have sufficient cushion to withstand such reverse flows of capital."

He added: "Now, with the global rise in the interest rates, there is always a lurking fear in the emerging market economies, that the level of capital flows may not be maintained. Thus, the comfort level of reserves should not be viewed with respect to the current situation alone but should also reckon the assessment of the emerging risks.

"Moreover, at this moment the global economy has not been tested on the eventuality of a not-so-orderly correction of the current global imbalances. In that eventuality, as the experts caution, disruption in financial markets in the form of large cross-currency volatility and sharp rise in interest rates are not unlikely in the global economy."

Note: Figures for March 2007.