The Hindu Business Line : Forex reserves: Sinking feeling?

India’s assiduously built foreign exchange reserves of $320 billion have melted down to around $240 billion just a few months – a huge drop of $80 billion and still counting.

It was always a bit of a mirage. The country had a trade deficit thanks to soaring oil prices and rapid non-oil import growth.

This was offset by the phenomenal progress of software and service exports and remittances, which converted the trade deficit into a small current account surplus (although this too has disappeared going by recent data).

But the icing on the cake (if one could call it that) was the massive inflows of foreign capital seeking the outsize returns on portfolio investments in the booming stock market, private equity and real estate, facilitated in no small measure by the welcome mat of Government for such investments through its open door policy and tax exemptions.

‘Hot money’

Predictably, there was a mad rush to take advantage of the super profit opportunities.

About a third or more of the reserve build-up was ‘hot money’, ready to flee the moment near-term profit goals were realised (or things became difficult).

But the Government was quick to put a spin of foreign investors’ strong belief in the Indian ‘growth story’.

What do we say now that the very same group exits tens of billions of dollars in weeks? Has the milk turned sour so soon?

Obviously, the investments were opportunistic in the first place and not out of faith in some distant long-term Indian promise.

This is not to lay the blame on foreign investors, who are understandably profit seekers pure and simple, but to emphasise that we are the best judge of our best interests.

The noted economist, Mr Jagdish Bhagwati, has long drawn attention to the dangers of uncontrolled foreign capital movements thriving only on arbitraging interest and exchange rates or plucking the low-hanging fruit in stocks, earning, in the process, risk free profits.

No benefit accrues to the host country out of such (mere) financial engineering. On the contrary, it is exposed to sudden capital flight when the scope for arbitrage disappears or risk perceptions change.

Corporate debt

Compounding the present situation is the forex debt of Indian corporates maturing for repayment in the next months. S

old to foreign investors as bonds convertible to equity in a seemingly everlasting stock market boom, they must now be paid back as current stock prices are far below conversion prices.

It is a mess: dollar debt in companies with only rupee incomes (e.g. real estate developers) and for thoughtless foreign acquisitions at the market top in pursuit of marquee brand names and multinational status.

Coming, as this timeline does, in trying business and market conditions and dwindling exports, banks must provide the rupee credit and the Reserve Bank of India the dollars for repayment.

Thus, our much-vaunted reserves could easily sink another $100 billion to the region of $150 billion. The rupee? Perhaps on course to Rs 55 against the dollar.