Dilemma Intact: How much forex reserves does India really need?

With the Reserve Bank of India (RBI) governor Raghuram Rajan shooting of a warning of certain global crash ahead, almost every emerging country is busy performing math calculating amount of forex reserves required to face off any contingency.

Dilemma Intact How much forex reserves does India really need

Talking about India, we can boast about an all time high foreign exchange reserves today, but they are still much lower than what we saw during our ‘peak’ in terms of months of imports – in fiscal year 2004 when they covered nearly about 17 months.

At present, we have reserves to cover eight months of imports, but they are much lower than the year 2008-09 as well, just after Lehman crisis hit the world.

Carrying out a rough calculation, if we suppose forex reserves stay put at present level and imports see an increase by 10% this fiscal year in comparison to the 2013-14 level, reserves will come down to 7.5 months at the end of the year 2015. This is much lower than what we had in 2000, but higher than in 2012-13.

To add to it, the calculation doesn’t take into account $30 billion of the reserves which the RBI has to unwind. The amount was raised as net forward positions through FCNR (B) deposits last year through special swaps.

Furthermore, the forex reserves, in case of India, haven’t been built through excess of exports over imports, but by Foreign Institutional Investment (FII) inflows. And, once the Quantitative Easing (QE) ends, hot money may cease to exist.

And, as global economy and domestic industrial environment improves, India may observe imports increasing, further leading to outflows of dollars.

However, RBI is wise enough to keep buying dollars, continuously adding to reserves, preventing the rupee from appreciating, which is good for exports. But, it appears tough to calculate how much month of import reserve India really needs to ward of any kind of risks.

From Jun 2014, RBI has sold about 150,000 cr. of government bonds it holds, and has instead replaced them with dollars. After election results, the RBI has purchased about Rs. 2 trillion worth of dollars (200,000 cr of dollars).

Considering tough days ahead, as governor predicts, RBI must devise a suitable line of attack to tackle any kinds of risks emanating in the days ahead.

Ashish Pandey

I am a business and finance journalist who is currently employed at Financial Express and previously at Zee News. My areas of interest include business and foreign policy. You can reach me on Twitter at @ashuvirgo1984 or @eFundsPlus.

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