Why Huge Forex Reserves YV Reddy Refuses To Bite

New Delhi, May 10: | Updated: May 11 2002, 05:30am hrs
How much is enough and is economic growth being sacrificed for the comfort of accumulating foreign exchange reserves A sharply defined debate on these two questions facing the forex managers was kicked off here on Friday by Reserve Bank of India deputy governor Yaga Venugopal Reddy, with opinion divided among economists on whether the central bank should continue to accumulate reserves or use them to stimulate growth.

Delivering a lecture on Indias foreign exchange reserves: Policy, status and issues, under the auspices of the National Council of Applied Economic Research, Dr Reddy said the 1990s marked a traumatic transition for those managing the external sector from the agony of 1990-91 to the current phase of comfort or even ecstasy.

Defining comfort: RBI deputy governor YV Reddy delivering a lecture on Indias foreign exchange reserves: policy, status and issues in New Delhi on Friday
Defining comfort in a variety of ways, Dr Reddy zeroed in on the stability of financial markets and the assurance of external confidence as the driving elements defining the countrys forex management. In a world of liberal flows and globalisation of financial markets, it is no longer import cover that defines forex adequacy but the insurance against risk, the assurance of stability, the management of lumpiness in the demand and supply of currency, geo-political and strategic factors and so on which define the adequacy of reserves, he asserted.

While stating that the central bank has to exercise informed judgement in determining the appropriate level of reserves, Dr Reddy did not elaborate RBIs own view of whether the current level was adequate or not, though he repeatedly termed it as comfortable.

Several economists who participated in the debate argued that the government and RBI should worry less about accumulating reserves and utilise them to generate higher growth. Chairing the meeting, former finance minister P Chidambaram said RBI had initiated an important debate which must be joined by experts and policy-makers.

Dwelling on the concept of forex reserves, Dr Reddy said, here they refer to both foreign reserves in the form of gold assets in the banking department and foreign securities held by the issue department, as well as domestic reserves in the form of bank reserves.

As to why reserves should be held at all, he averred that official reserves are held for precautionary and transaction motives keeping in view the aggregate of national interests, to achieve balance between demand for and supply of forex, for intervention, and to preserve confidence in the countrys ability to carry out external transactions.

Tracing the evolution of the reserve management policy, he recalled that till the balance of payments crisis of 1991, after which the stress was on import cover of reserves in terms of number of months. A paradigm shift since 1993-94 has culminated in a multiple indicators approach now and the weights attached to each of them keeps changing too.

Dr Reddy listed the money-based indicators, trade-based indicators, debt-based indicators and liquidity risks as the four sets of indicators that together explain the adequacy of reserves. The essence of portfolio management of reserves by RBI, he said, was to ensure safety, liquidity and optimisation of returns, and the strategies were continuously reviewed in consultation with the government.

Dr Reddy also pointed out that as regulator, sterilised intervention by it to contain the liquidity impact of capital flows often involved a trade-off between low-return and high-return assets. Earning from deployment of forex was understandably lower than the interest loss from open market sale of government securities owing to interest rate differentials.