subject: India's foreign exchange reserves: Cushioning the blow! [print this page] India's foreign exchange reserves: Cushioning the blow!
India's foreign exchange reserves touched USD 300 billion as per the November 12, 2010 RBI weekly supplement.
India's foreign exchange reserves have grown significantly since 1991. In Circa 1990 the Indian economy held foreign exchange reserves equivalent to a meager three weeks of import cover, which touched a peak of 16.9 months in March 2004 and currently stands at about 12 months. The growth of foreign exchange reserves is a testimony to the fact how well India has grown and has gained trust in aspects of trade, preferable investment destination and fair practices.
The reserves, which stood at USD 5.8 billion at end-March 1991 increased gradually to USD 54.1 billion by end-March 2002. The reserves stood at USD 279.1 billion as on March 31, 2010.
How much is too much?
Academician, policymakers have debated about the right amount and proportion of foreign exchange reserves. If one were to consider the ongoing' financial crisis as a precedent the economist would argue in favour of the as much as possible rationale. However, there is an opportunity cost as countries would enjoy little additional benefit for having excess reserves. Additionally, as was witnessed in the recent financial crisis, countries made use of reserves to ward off negative effects of financial downturn. India's foreign exchange reserves after touching an all-time high of USD 313.50 billion dropped USD 252.88 billion in Q1 2009, before treading upwards again (See above graph).
A recent IMF paper titled The Impact of the Great Recession on Emerging Markets' highlights countries that had more reserves going into the crisis made greater use of them during the crisis period in order to avoid sharp depreciations that could have had pronounced implications on corporate, household, and bank balance sheets, potentially creating a systemic event. For example, as the crisis unfolded, Russia spent more than USD 200 billion of its reserves (representing 13% of 2008 GDP, one of the largest declines amongst EMs) in tempering the pressure on the ruble. Having reserves helped Russia, for example, to avoid a systemic financial crisis by allowing some space for corporates and banks to adjust to a revised global outlook with lower oil prices. The figure below plots the peak to trough sale of reserves in percent of 2008 GDP. On average countries lost around 7% of their GDP equivalent of international reserves either to protect the currency or the balance sheets.
