Anatomy of forex reserve

March 4, 2004

Anatomy of forex reserve
Our Happiness is an illusion

Money you know will hide many faults, says Cervantes in his book Don Quixote. It is one of the facts of life and the BJP-led NDA government at the Centre relied in this theory while embarking on advertisement campaign commonly known as 'India Shining.' They blew the Conch to begin the election battle as in the Mahabharata when Yuddhisthir was tempted to use the language “ Ashwasthama Hato…” that ultimately deceived the opposition to be killed. Srikrishna blew the Conch too loudly to deafen the ears and nobody heard Yudhisthir's words of truth.

This time the government has made an appeal to the people to 'feel good, feel great' and has given a reason for that that we have over 103 billion dollars in our foreign exchange kitty. Money is, of course, one of the greatest source of joy and what a joy we are expressing through media that has been derived from the almighty dollar, the great object of universal devotion throughout our land ! We seem to be simply blinded by the brightness of the dollar and deafened by the roar of joy emanating out of the unprecedented level of foreign reserve. It has become far more persuasive than logical arguments, and we tend to ignore the other facts having potential to create itself one of the greatest source of anxiety.

Only the government or the Reserve Bank of India knows the real and up to date status of the foreign exchange reserve and therefore unless they come out with a comprehensive report, we have to depend on the latest report of the RBI that includes the dada only up to September 2003. The reason is best known to the custodians of the data who preferred not to bring out the data till January 31, 2004. No one can believe that it was beyond their capability.

Whatever data is given in the RBI report is , however, informative. The foreign exchange crisis of 1991 is specifically mentioned when our reserved was only 5.8 billion dollars as on March 31. It swelled up to 94.6 billion dollars till September 2003. Indeed, a great leap forward.

But when we see at the overall figures, it compel us to think. The had 115.5 billion dollars in the net capital account, but we lost 31.4 billion dollars as trade deficit, which is in fact a negative contribution from current account of both goods and services. In simple terms, we accumulated this huge forex reserve mainly through borrowed money in different heads which are in fact liabilities of our country. Foreign investment brought 55.4 billion dollars, NRI deposits 21.8 billion , External assistance 11.8 billion, External commercial borrowing 15.3 billion, and other items in the capital account 11.2 billion dollars. We are to pay a heavy cost on these dollars, while the RBI informed us that it adopted various methods to ensure that the reserves are invested in safe and liquid assets. However, this huge reserve had a very low level of return ( about only two per cent ) in 2003 due to global low interest regime. This does not justify the government's wisdom to pay much higher return to other countries, international financial institutions, multinational companies or NRIs.

When we look at the international investment and liabilities position of India, it punctures the euphoria over the riches. Our total foreign assets as on March 2003 was about 94.68 billion dollars, of which direct investment abroad was only 5 billion dollars, portfolio investment 0.72 billion and other investments 12.8 billion dollars. The foreign exchange reserve was of 76 billion dollars. As against this our total foreign liabilities was 154.75 billion dollars. This liability includes FDI in India ( $ 30.8 billion), Portfolio investment ($ 32 billion) and other investments ( $ 91.7 billion). So, our liabilities were 60 billion dollars larger than our reserve.

Let us see what we do with this huge pile of foreign exchange. As on September 30, 2003 , our total foreign currency assets was 87.2 billion dollars. Out of this, 31.7 billion dollar was invested in Securities , 39.64 billion dollars were deposited with other central banks and BIS, and 15.83 billion dollars were deposited with foreign commercial banks. It is now on record that we earned only 2 per cent from this reserve, while some of these forex flow back to India as external commercial borrowing by Indian Corporates on which we pay much greater return.

Keeping all these figures in mind along with the value of the US dollar falling in the international market, the actual earning must be much below two percent. Compared to our GDP, our forex reserve is at present about its 20 per cent. Therefore, there is much on stake, and it would certainly be a matter of debate after the Lok Sabha elections are over. The issue would be how much forex reserve should be maintained by India and at what cost.

As of now, the status of our foreign exchange reserve is : we have accumulated over 100 billion dollars and created over 160 billion dollar of liabilities. Thus the cost is obviously unsustainable.

This phenomenon can be properly understood by analogy. Accumulation of wealth in possible only through two legal means. Firstly, by creating or earning assets and secondly, through increasing liabilities. It's simple common sense. And we know the greatest philosophy is a greatest common sense. So, a man is doomed if he accumulated money through increasing his liabilities more than he earns or creates assets for himself. It would follow miseries, as Charles Dickens points out in David Copperfield.

Our Government at the Centre, unfortunately, followed the second path. Take the latest example of the data released on March 1, 2004 by the Directorate General of Commercial Intelligence and Statistics, which says and subsequently highlighted by the media, that the country's export posted a growth of 9 per cent during January last in dollar terms with the overall export growth during the first ten months of the current financial year slightly ahead of the target rate at 12.83 per cent. This news may give certain satisfaction to the common people about the performance of the government and in an election year the NDA led government may hope for more votes. But it is only the half truth. The whole truth is that as compared to 2002-03, our imports grew in 2003-04 from 49.6 billion dollars to 61.9 billion dollars. Thus our loss in terms of trade deficit was almost doubled from 7.5 billion dollars to 14.4 billion dollars. In this way, instead of some earning , the net result in loss.

As far as creating assets is concerned, we lag much behind. Our deployment pattern of the forex reserve suggests that our government is much more interested in vely low earning deposits and securities. We are investing very little in export oriented ventures in India or abroad. Our FDI, portfolio, or other investment abroad was only 17.8 billion dollars as on March 2003.

In this scenario, a million dollar question is , how can our country earn or create assets in terms of foreign exchange or why we can't use our dollars in more profitable investments, domestic or abroad ? It would be naïve to assume that the persons at the helm of affairs are unaware of this commonsensical wisdom. There must be some other motif behind this.

In spite of that NDA led government was able to get applaud from our intelligentsia. A lobby became active, and suggested that our country should make prepayment of some of our liabilities to create a feeling among voters that everything is good in the forex management and our miseries are now over. We also made some prepayments for some short-term loans having high rates of interest. It sounds good and it helps up to a great extent. However, the time ahead for the RBI seems to be too difficult to handle.

We have made such a policy, that attracts all sorts of overseas investors, and many of them are simply interested in parking their money in our country for more profits creating not our assets and earnings but liabilities. At the moment, this phenomena seems to be under manageable limit. Nobody, except the government and RBI, knows its cost due to lack of public data. Weakening dollar and the pressure from the US to allow our rupee to appreciate would soon be a source of anxiety. Is it possible for us to pay our liabilities without earning dollars or creating assets? (EOM)