High foreign exchange reserves to help comfortably repay $ 563 billion worth of foreign debt – The New Indian Express

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Express news service

India’s foreign exchange reserves hit a record high of $ 605 billion last week. This means that we can now comfortably repay our full external debt of $ 563.5 billion in December 2020 while staying with cash. Since the balance of payments crisis of 1991 which caused “a threat of national humiliation”, the 30-year journey from “agony to comfort” is indeed a matter of pride.

But why hold foreign exchange reserves? And does a higher number bring more prosperity? Foreign exchange reserves are external assets available to the RBI to cope with any external shock. The most important of these is to protect the currency from volatility. The RBI law clearly states that a stable exchange rate is the overall objective of its foreign exchange reserve management policy. But it also has an underestimated goal of supporting monetary policy by ensuring liquidity in the forex market.

In addition, it limits external vulnerability by maintaining liquidity in foreign currencies to absorb shocks during crises like the taper tantrum event of 2013, gives confidence to markets, especially rating agencies, as external bonds can easily and always be respected. This is essential because it helps to reduce costs and, above all, encourages the sovereign to borrow abroad. Until the balance of payments crisis of 1991, reserve management relied primarily on the traditional business approach of calculating import coverage, which fell to a deplorable 3 weeks in December 1990.

In December 2020, our import coverage reached 18.6 months. However, it has undergone a paradigm shift and the adequacy of reserves is now determined from three other indicators. The first is a money-based indicator that hints at potential capital flight from residents. On this basis, the proportion of net foreign exchange assets to currency with the public has increased sharply, from a dismal 15% in 1991 to 157% on May 21. Likewise, its proportion to broad money (M3) increased from 3% to 23.8%. . Should there be a flight of capital in the event of rising interest rates in developed markets, any resulting volatility can be tackled by injecting rupee liquidity through dollar sales.

Second, debt-based indicators assess the risks associated with adverse developments in domestic capital markets. Since short-term debt provides a measure of all debt repayments to non-residents, it is a useful measure of how quickly a country would be forced to adjust during capital market distortions. It is the important indicator of the adequacy of reserves in countries with significant but uncertain access to capital markets.

Here is where we are: the proportion of short-term debt (with a maturity of up to one year) to foreign exchange reserves fell from 147% in 1991 to 17.7% in December 2020. A lower percentage indicates less debt obligations and therefore good. Likewise, the proportion of volatile capital flows (including cumulative portfolio inflows and short-term debt) to reserves has also been reduced from 147% in 1991 to 67% in December 2020. Foreign exchange reserves are made up of all items except three, gold, SDRs and foreign currencies. foreign currency assets.

As of June 4, of the $ 605 billion in total foreign exchange reserves, foreign exchange assets accounted for about 93% to $ 560 billion. At the last count, more than 67% of this amount is invested in securities (including US dollar, euro, British pound and Japanese yen). Most securities are considered liquid because RBI makes money through buy-sell transactions, although this income is not attractive given the ultra-cheap rates.

The crucial question is whether other external assets are easily usable. Gold in particular, which accounts for 6.2% of official reserves, is not of a quality easily accepted in international financial markets, according to former RBI governor YV Reddy. That said, he felt that India had developed a mechanism whereby part of the gold holdings could be converted into usable foreign currencies.

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