Mains Paper 3: Economy
Prelims level: Forex Reserve
Mains level: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment
• India’s forex reserves have crossed an unprecedented mark — over half trillion USD — placing India only behind China and Japan in Asia.
• And while it may seem like a ray of hope amidst the economic turmoil in the country, one must scrutinise its utility.
• The issue is not about a “few extra” reserves but unused “excessive” reserves.
• This may indicate that the Indian government is likely anticipating the need of an enormous economic stimulus and hence is banking on these reserves to support the failing Indian economy.
• If so, over-reliance on forex reserves to provide this stimulus may be dangerous and merely keeping reserves parked now is an opportunity lost.
Factors that lead to surge:
• The recent forex reserves surge was a result of two things: A spike in foreign institutional investments and savings in India’s import bill.
• Foreign institutional investors reinvested in the Indian market in May-June 2020 after they exited their positions in panic in March.
• On the other hand, a global fall in fuel prices has reduced India’s oil import bill allowing it to save up forex reserves.
• But why does India keep huge forex reserves despite the government’s claim that the “fundamentals” of the economy are strong?
• Sufficiency of forex reserves is sometimes measured on how many months’ worth of imports can a country afford.
• While six months is considered sufficient, the RBI in December 2019 said it had enough to sustain for 10 months (the forex reserves were then $ 0.4 trillion). Today the cover is 12 months!
• This is despite having a sufficient credit line from the IMF, should there be a credit shock.
• It is understandable for oil rich countries — which largely sustain on international oil trade — to maintain high forex reserves.
• A single oil trade hiccup can derail their economy.
• Economist have theorised that holding high forex reserves are unnecessary.
• In fact not using them for mega-projects (like financing infrastructure projects) are lost opportunities — and yet the Indian government has held these reserves in liquid, possibly for its feared D-day.
• Has the Indian government been anticipating an economic hiccup strong enough to derail the Indian economy?
• Indeed, excess forex reserves are likely the government’s contingency fund that it may resort to should the Indian economy suddenly topple.
• The pandemic has in fact increased the government’s insecurity.
• A mere two months into this fiscal year and the government’s fiscal deficit stands at 58.6% of the budgetary target for the current fiscal year — a result of accelerating its budgetary spending to deal with the virus.
• Another possibility is that the government is accumulating these reserves as a “Plan-B savings” should India’s strategic disinvestment plans fail.
• Third, forex reserves are also likely a way for India now to maintain its global rating after multiple reductions in its GDP growth estimates.
• For instance, Fitch revised its India growth forecast for 2021-22 to 8 per cent from 9.5 per cent on June 30.
• The government needs something to give its investors to hold onto.
• Last but not least, the fundamental use of India’s foreign exchange should be to ensure the rupee stability.
• However, that hasn’t been the case. Despite steadily rising forex reserves, the rupee has fluctuated between 77 and 75 against the US dollar in the last two months, between 71 and 77 in the last three months, and 68 and 77 in the last one year.
• The rupee has become one of Asia’s worst currencies and the RBI may allow the rupee to devalue further to support its balance sheet, enabling it to transfer a big chuck of its realised profits as dividend to the starving government.
• With “Aatmanirbharta” or “self-suffienciency” int he spotlight, even financing imports is out of the picture.
• Neither will they be used to bid the rupee against other currencies since investors will not hold it.
• Clearly, not using forex reserves for its prime purpose despite having them in excess suggests that they are being held for an ulterior motive.
Dip in investments:
• But if the foreign fund influx is a plus, over-reliance on these floating funds that add to forex reserves to stimulate the economy might be poorly informed.
• The potential of these funds to switch direction should not be underestimated.
• In March alone, foreign institutional investments in India fell by Rs 65,000 crore (due to coronavirus panic).
• India’s foreign exchange reserves registered this impact — they shrunk by $ 12,577 million over approximately the same period.
• Reversing the dip, investments again went up in May, adding nearly Rs 14,000 crore, with some big corporate deals that restored forex reserves to their early 2020 levels.
• In June, Rs 6,000 crore worth of foreign investment came in.
• If the government does intend to use forex reserves as an emergency fund, it should ensure that they do not shrink just when they are most needed.
Q.1) With reference to the Pradhan Mantri Mudra Yojana (PMMY), consider the following statements:
1. Under PMMY, loans for income generating activities up to Rs 5,00,000 are termed as Shishu loans.
2. Union Cabinet approved a scheme for interest subvention of 2% for a period of 12 months, to all Shishu loan accounts under Pradhan Mantri Mudra Yojana (PMMY) to eligible borrowers.
Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Q.1) What is Forex Reserve? Discuss its relevance for India? Why are forex reserves rising despite the slowdown in the economy? How over-reliance on forex reserves to support the Indian economy can be dangerous?