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Wednesday, Jul 02, 2003

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The `other capital' factor in forex reserves accretion

Harish Damodaran

But it is the jump in `other banking capital' from minus $1.5 billion in 2000-01 to $2.8 billion in 2001-02 and $5.4 billion in 2002-03 — that is truly baffling.


THE country's foreign exchange reserves may have swelled by $20.8 billion during 2002-03, but there is still considerable ambiguity over the real sources of this accretion.

Broadly speaking, the increase in reserves has been brought about by a current account surplus of $3.7 billion and net foreign capital inflows of $13.6 billion.

The remaining $3.8 billion has been due to valuation changes, arising from the weakening of the dollar vis--vis other major international currencies.

During 2002-03, the dollar fell by 19.4 per cent against the euro, 11.1 per cent against the yen and 8.9 per cent against the pound.

In the past, the impact of such currency fluctuations on reserve levels was limited, given that the bulk of the Reserve Bank of India's foreign currency assets was held in the form of dollars. However, since the RBI's reserve portfolio now includes a sizeable holding of non-US currencies, the strengthening of these currencies vis--vis the dollar has led to a `gratuitous' rise in the dollar-denominated value of its reserves. The accompanying Table shows that, unlike in the previous years, valuation changes, courtesy a weak dollar, explain for 18.5 per cent of the total reserve build-up during 2002-03. While the broad components underpinning the accretion to reserves are known, the picture is, however, hazy with regard to the sub-components.

This is especially so in the case of foreign capital inflows, which, in net terms, amounted to $13.6 billion in 2002-03, up from the previous year's $10.6 billion.

This jump has taken place, notwithstanding declining, or even negative, inflows from conventional sources of foreign capital, be it foreign investment, external assistance or commercial borrowings. Inflows under non-resident deposits, too, have risen by a minuscule $ 54 million.

The main contributors to higher capital inflows have been `other banking capital' and `other capital'. `Other capital' is a residual category, largely pertaining to delayed export receipts resulting from the leads and lags between physical shipment of goods and the receipt of funds through banking channels. Inflows under `other capital' have soared from a mere $158 million to $3.3 billion in 2002-03 and according to the RBI, much of the latter ($3.2 billion) comprises delayed export receipts.

It is surmised that the rupee's continuous strengthening against the dollar would have prompted exporters to bring in their proceeds being held abroad, which, in turn, has manifested itself as higher delayed export proceeds.

But it is the jump in `other banking capital' - from minus $1.5 billion in 2000-01 to $2.8 billion in 2001-02 and $5.4 billion in 2002-03 — that is truly baffling.

Inflows under this head have, in fact, contributed to over 26 per cent of the increase in reserves last year. Of the total $5.4 billion, the bulk ($4.9 billion) comprises increase in the foreign currency holdings of commercial banks. The question to be posed is: what exactly is the source of the increase in these assets?

The foreign currency held by banks is usually on account of proceeds from exports, inward remittance, NRI deposits, etc.

However, since these are already accounted for in other specific balance of payments (BoP) heads, there is obviously something `extra' to the build-up in `other banking capital'.

The issue assumes significance more so, when the increase in banks' foreign assets was to the tune of $4.9 billion in 2002-03, compared to $2.8 billion and minus $1.5 billion in the preceding two years.

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