INDIAN FOREX RESERVE MOVEMENT

SUBMITTED BY
DEBAPRATIM DUTTA
REGD. NO.-09KB042
 KRUPAJAL BUSINESS SCHOOL
(

CERTIFICATE
This is to certify that the project report entitled “INDIAN
FOREX RSERVE MOVEMENT”. In partial fulfillment for the award
of the ‘INTERNATIONAL FINANCE’ of Post Graduate Diploma in
Management, an excellent work done by Debapratim Dutta bearing
Regd. No. 09KB042 under my guidance and supervision, and no part of
the report has been submitted for the award of any other degree or
published in any other form to the best of my knowledge and belief.

I wish her all success in future.

Under The Guidance Of

CA. Prithvi Ranjan Parhi (M.Com, FCA,
DISA (ICAI)
International Finance
Krupajal Business School
Bhubaneswar.
 Executive Summary

General View

Ø The respective project is based on “Forexs Reserve

movement”
Ø The project is based upon certain “Assumption” .
Ø This project is done through the Guidance of Prithvi
Ranjan Parhi
Ø The respective project work is done by using the help of
Internet and Human Intelligence of the Assignee.
Ø The objective of the project is to find the Indian Forex
reserve movement and analysis.
INTRODUCTION

Foreign exchange Market

In a typical foreign exchange transaction a party purchases a quantity of one
currency by paying a quantity of another currency. The modern foreign exchange
market started forming during the 1970swhen countries gradually switched
to floating exchange rate from the previous exchange rate regime,
which remained fixed as per the Bretton Woods System.

SOURCES AND USES FOREX

The main sources of foreign exchange are-

• Export earnings from goods and services
• Remittances from overseas
• Direct investment flows
• Private and official loan inflows

A forex market is a market that facilitates exchange of currencies. The world is emerging as a global
economy because of flow of goods, services and capital. For each transaction of goods and services
there is a corresponding currency transaction, which forms a part of an international network of
payments. The increase in world trade and the lowering of capital controls have led to tremendous
growth in the foreign exchange market over the years. It offers unparalleled personal
and financial freedom to make money as well as lose it in no time. It is described as the „fairest
market on earth
for it is so large that no one player, not even large government can completely
control its directions.

The Indian forex market is in its evolving stage, the market is described as thin with few players and
low volumes unlike the global scenario. The main reason for low volumes is the no convertibility of
rupee on capital account. This research report will give insight about the evolution of the Indian
forex market and the importance of forex market in a developing economy like India.

The foreign exchange market has gained a lot of importance in recent years and has become an
essential part of every economy.
India being one of the fastest growing economies of the world and its ambition to become a
developed economy by 2020, it needs a developed forex market to back its economy. This research
report will help us understand the existing scenario of the Indian forex market and what changes
will help it to become a developed forex market.

We cannot designate any physical location where forex traders get together to exchange currencies.
Rather, traders are located in offices of major commercial banks around the world and
communicate using computer terminals, telephones and other information channels. The
international scope of the forex market implies the absence of any central regulatory authority.
Instead the forex market provides an example of private regulation, where market participants
agree on a common set of rules governing transactions and their settlement. Hence, the forex
market is certainly not a chaotic realm of lawlessness. In fact ethical and professional standards are
essential in an economic environment in which a single verbal agreement on a telephone can
commit millions of dollars or euros.

The forex market differs from other financial markets in a number of respects. First, it is by far
the world’s largest financial market in terms of transaction volume. The daily transaction volume
in all currencies is estimated to amount to $3.98 trillion a day. This is gigantic even in comparison
to a very active equity market like the New York Stock Exchange, which reaches an average daily
volume of approximately US$ 296 billion a day.

Secondly, the forex market is also a market with extraordinarily low transaction costs. A common
measure to express transaction costs is to calculate quoted spreads as the price difference between a
buy (ask) and a sell ( bid) order for a currency rate relative to the mid-price. Such quoted spreads in
the forex inter-bank market can become as low as 0.5 to 1.5 basis points(a basis point is 1% of 1%,
i.e. 0.0001) for the most liquid currency pairs. Quoted spreads inequity markets tend to be 50 times
larger even for the most liquid stocks. These are some of the reasons why the forex market is known
as the fairest market of the world.

As per the BIS Triennial Survey on the global foreign exchange and derivatives market activity
(2007), the foreign exchange market in India has grown into the 16th largest market in the world in
terms of total daily turnover which was US$34 billion in 2007. The OTC derivatives segment to f
the foreign exchange market has also increased significantly to register a daily average turnover of
USD 24 billion, which is 17th largest among all countries. The daily turn over has increased to
US$48 billion in 2007-08.

There is no ready template available internationally that India could draw upon since most of the
countries that have active currency futures markets are those which are relatively more
convertible on the capital.

The introduction of currency futures last year has provided further depth and breadth to the
market and fulfill the intended objective as an effective risk-management instrument. This is
leading to an urge in all the market participants to leverage this significant milestone for skill
development within as well as at a broader industry level.

FOREXDERIVATIVES IN INDIA
In respect of forex derivatives involving rupee, residents have access to foreign exchange forward
contracts, foreign currency-rupee swap instruments and currency options - both cross currency as
well as foreign currency-rupee. In the case of derivatives involving only foreign currency, a range of
products such as IRS, FRAs, option are allowed. While these products can be used for a variety of
purposes, the fundamental requirement is the existence of an underlying exposure to foreign
exchange risk whether on current or capital account.

During the first year of the launch of exchange traded currency futures reveals growing interest in
the market. However, these markets have not been able to evince the kind of activity that OTC
markets are witnessing. Many corporate using currency derivatives for hedging their foreign
currency exposure find requirement of margin and settlement of daily mark - to– market
differences cumbersome especially since there is no such requirement for OTC trades. It would
perhaps take some time for them to realize the concomitant benefits of these risk containment
measures. There is a perceive resistance to change or switch over from OTC to Exchange traded
framework with the grip and comfort ability level in the OTC markets.
In conclusion, considering the nascent stage of development of these markets in the country, the
cautious approach of the regulators is understandable. One hopes to see further developments in
exchange traded currency markets over time. There is no doubting that this is a market which will
eventually establish its niche and would be an area of activity to watch and gain from for all market
participants in the near future.
With the passage of time, India’s exchange rate policies will continue to evolve. The policy of
managing the Rupee-US Dollar exchange rate is likely to continue for some time to come.
However, over time as the Euro gains in importance, it will probably be become a key ingredient
in setting the “target” value of the currency. Trading in currency and its derivatives is likely to
increase and the involvement of foreign banks is expected to go up. The introduction and
popular trading of currency futures on the rupee may bring about greater informational
efficiency in currency trading markets at the risk, however, of making the markets more
speculative.

The philosophy of cautious liberalization is likely to continue among Indian policy makers.
Financial stability and avoidance of Asian Crisis-type catastrophes are likely to remain paramount
in the exchange rate management system. However, if the accumulation of US dollar reserves
continues to progress uninhibited or if the economy experiences external shocks like anoil shock, it
may trigger some rethink of the exchange rate policy. Of course a lot depends on the nature– both
size and composition– of cross-border investment flows. The UPA government “decision to tax
interest on the nonresidentIndians
deposit shows the country’s heavy dependence of such flows is
a thing of the past. If China is any indication, India should be able to attract several times the global
investment it presently does.

In barely a decade and a half since the beginning of liberalization, India’s external finances
haveundergone a complete transformation. From a foreign exchange-starved, control-ridden
economy, India has moved on to a position of $250 billion plus in international reserves with a firm
rupee and with far less forex control. In 1999 the notorious FERA (Foreign Exchange Regulation
Act) gave way to the much milder FEMA (Foreign Exchange Management Act). The role of policy
makers, however, is no less important today than before. With the added freedom and ease of
transaction comes the risk of exposure to the vagaries of world financial markets. Prudent policy
and careful monitoring are necessary to reap the benefits of external sector liberalization without
taking inordinate amount of risks.
 MOVEMENT OF RESERVES

1. INTRODUCTION
The level of foreign exchange reserves has steadily increased from US$
5.8 billion as at end-March 1991 to US$ 113.0 billion by end-March 2004
and further to US$ 141.5 billion by end-March 2005 (Table 1). Although
both US dollar and Euro are intervention currencies, the foreign exchange
reserves are denominated and expressed in US dollar only.

(US $ million)
Date FCA SDR GOLD RTP Forex Reserves
30-Jun-03 78,546 1 (0.9) 3,698 976 83,221
30-Sep-03 87,213 4 (2.5) 3,919 1,203 92,339
31-Mar-04 107,448 2 (1.6) 4,198 1,311 112,959
30-Sep-04 114,083 1 (1.0) 4,192 1,303 119,579
31-Mar-05 135,571 5 (3.0) 4,500 1,438 141,514

Note:

1. FCA (Foreign Currency Assets): FCA is maintained as a multicurrency

portfolio, comprising major currencies, such as, US dollar, Euro, Pound
sterling, Japanese yen, etc. and is valued in US dollars.
2. SDR: Values in SDR have been indicated in parentheses.
3. GOLD: Physical stock has remained unchanged at approximately 357
tones.
4. RTP refers to Reserve Tranche Position in IMF

2. REVIEW OF GROWTH OF RESERVES SINCE 1991

India’s foreign exchange reserves have grown significantly since 1991.
The reserves, which stood at US$ 5.8 billion at end-March 1991 increased
gradually to US$ 25.2 billion by end-March 1995. The growth continued in
the second half of the 1990s, with the reserves touching the level of US$
38.0 billion by end-March 2000. Subsequently, the reserves rose to US$
54.1 billion by end-March 2002, US$ 76.1 billion by end-March 2003, US$
113.0 billion by end-March 2004 and further to US$ 141.5 billion by end-
March 2005 (Chart 1). It may be mentioned that forex reserves data prior
to 2002-03 do not include Reserve Tranche Position (RTP) in IMF, as RTP
has been included as part of the forex reserves only recently. Table 2
details the major sources of accretion to foreign exchange reserves during
the period from March 1991 to March 2005.
 ACCRETION TO FOREIGN EXCHANGE RESERVES SINCE 1991
1991-92 to 2004-05 (up to
Items
end-September)
A Reserve Outstanding as on end-March 1991 5.8
B.I. Current Account Balance -22.8
Capital Account (net)
B.II. 149.2
(a to e)
a. Foreign Investment 77.3
b. NRI Deposit 22.4
c. External Assistance 10.5
d. External Commercial Borrowings 21.0
e. Other items in capital account 18.0
B.III Valuation change 9.3
Total (A+BI+BII+BIII) 141.5

3. SOURCES OF ACCRETION TO RESERVES IN THE RECENT

PERIOD

The increase in foreign exchange reserves in the recent period has been
on account of capital and other inflows. Major sources of increase in
 foreign exchange reserves have been: (a) Foreign investment (b) External
commercial borrowings (c) Banking capital (d) Short-term credit, and (e)
Other items under capital account. Table 3 presents sources of accretion
to reserves during April-March, 2004-05.

Sources of Accretion to Foreign Exchange Reserves (US $

billion)
April- April-
Items September September
2004-05 2003-04
I. Current Account Balance -6.4 10.6
Capital Account (net)
II. 32.6 20.9
(a to f)
a. Foreign Investment 11.9 14.8
b. Banking Capital 4.0 6.2
Of which: NRI Deposits -1.1 3.6
c. Short-term Credit 3.8 1.4
d. External Assistance 1.9 -2.7
e. External Commercial Borrowings 5.9 -1.5
f. Other items in Capital Account 5.1 2.7
III. Valuation Change 2.4 5.4
Total (I+II+III) 28.6 36.9

An analysis of the sources of reserves accretion during the entire reform

period from 1991 onwards reveals that the increase in forex reserves has
been facilitated by an increase in the annual quantum of foreign direct
investment (FDI) from US $ 129 million in 1991-92 to US$ 4.7 billion in
2003-04. During the financial year 2004-05, the quantum of FDI inflows
into India was of the order of US$ 4.7 billion. Outstanding NRI deposits
increased from US$ 13.7 billion at end-March 1991 to US$ 33.3 billion at
end-March 2004 but declined to US$ 32.9 billion as at end-March 2005.
FII investments into the Indian capital market, which commenced in
January 1993, have shown significant increase over the subsequent years.
Cumulative net FII investments, increased from US$ 827 million at end-
December 1993 to US$ 25.8 billion at end-March 2004 and further to US$
35.9 billion as at end-March 2005. Turning to the current account, India’s
exports which were US$ 17.9 billion during 1991-92 increased to US$ 63.8
billion in 2003-04 and further to US$ 79.2 billion in 2004-05. Invisibles,
such as, private remittances have also contributed significantly to the
current account. Net invisibles inflows increased from US$ 1.6 billion in
1991-92 to US$ 26.0 billion in 2003-04 and further to US$ 31.7 billion in
2004-05. India’s current account balance which was in deficit of 3.1 per
cent of GDP in 1990-91 turned into a surplus of 0.7 per cent in 2002-03. A
surplus of US $ 10.6 billion was posted in the current account during the
financial year 2003-04, driven mainly by the surplus in the invisibles
account. However, this could not be sustained during 2004-05, with the
 current account posting a deficit of US$ 6.4 billion, driven mainly by the
surge in oil prices in the international market

4. EXTERNAL LIABILITIES VIS-‫ہ‬-VIS FOREIGN EXCHANGE

RESERVES

The accretion of foreign exchange reserves needs to be seen in the light of

total external liabilities of the country.

India’s International Investment Position (IIP), which is a summary record

of the stock of country’s external financial assets and liabilities, is
available as of March 2004.

INTERNATIONAL INVESTMENT POSITION OF INDIA(US $

million)

Items March 2004 P

A. Assets
1. Direct investment abroad 6,592
2. Portfolio investment 732
3. Other investments 15,697
4. Foreign Exchange Reserves 112,959
Total Foreign Assets 135,980
B. Liabilities
1. Direct investment in India 38,676
2. Portfolio investment 43,856
3. Other investments 102,043
Total Foreign Liabilities 184,575
Net Foreign Liabilities (B-A) 48,595

P: Provisional

Source: Official website of Reserve Bank of India (http://www.rbi.org.in)

5. PREPAYMENT/REPAYMENT OF EXTERNAL DEBT

The significant increase in forex reserves enabled prepayment of certain

high-cost foreign currency loans of the Government of India from the
Asian Development Bank (ADB) and the World Bank (IBRD) amounting to
US$ 3.03 billion during February 2003. During 2003-04, prepayment of
certain high cost loans to IBRD and ADB amounting to US$ 2.6 billion was
 carried out by the Government. Additionally, prepayment of bilateral loans
amounting to US$ 1.1 million was also made. Thus, the total quantum of
prepayments was of the order of US$ 3.7 billion during 2003-04. During
2004-05, prepayment of bilateral loan to the tune of US$ 30.3 million was
made.

6. FINANCIAL TRANSACTION PLAN (FTP) OF IMF

International Monetary Fund (IMF) designated India as a creditor under its

Financial Transaction Plan (FTP) in February 2003, in terms of which India
participated in the IMF’s financial support to Burundi in March-May 2003,
with a contribution of SDR 5 million and to Brazil in June-September 2003
with SDR 350 million. In December 2003, SDR 43 million was made
available to Indonesia under FTP. During 2004-05, SDR 61 million was
made available under FTP to countries like Uruguay, Haiti, Dominican
Republic and Sri Lanka. Thus, the total quantum of India’s contribution
under FTP was SDR 459 million at end-March 2005.

7. ADEQUACY OF RESERVES

Adequacy of reserves has emerged as an important parameter in gauging

its ability to absorb external shocks. With the changing profile of capital
flows, the traditional approach of assessing reserve adequacy in terms of
import cover has been broadened to include a number of parameters
which take into account the size, composition and risk profiles of various
types of capital flows as well as the types of external shocks to which the
economy is vulnerable. The High Level Committee on Balance of
Payments, which was chaired by Dr. C. Rangarajan, erstwhile Governor of
Reserve Bank of India, had suggested that, while determining the
adequacy of reserves, due attention should be paid to payment
obligations, in addition to the traditional measure of import cover of 3 to 4
months. In 1997, the Report of Committee on Capital Account
Convertibility under the chairmanship of Mr.S.S.Tarapore suggested four
alternative measures of adequacy of reserves which, in addition to trade-
based indicators, also included money-based and debt-based indicators.

In the more recent period, assessment of reserve adequacy has been

influenced by the introduction of new measures that are particularly
relevant for emerging market countries like India. One such measure
requires that the usable foreign exchange reserves should exceed
scheduled amortisation of foreign currency debts (assuming no rollovers)
during the following year. The other one is based on a 'Liquidity at Risk'
rule that takes into account the foreseeable risks that a country could
face. This approach requires that a country's foreign exchange liquidity
position could be calculated under a range of possible outcomes for
relevant financial variables, such as, exchange rates, commodity prices,
credit spreads etc.. Reserve Bank of India has done exercises based on
 intuition and risk models in order to estimate 'Liquidity at Risk (LAR)' of
the reserves.

The traditional trade-based indicator of reserve adequacy, viz, import

cover of reserves, which fell to a low of 3 weeks of imports at end-
December 1990, rose to 11.3 months of imports at end-March 2002 and
increased further to around 14 months of imports or about five years of
debt servicing at end-march 2003. At end-March 2004, the import cover
of reserves was 17.0 months, which came down to 14.3 months as at
end-March 2005. The ratio of short-term debt to foreign exchange
reserves declined from 146.5 per cent at end-March 1991 to 4.2 per cent
at end-March 2004 but increased slightly to 5.3 per cent as at end-March
2005. Similarly, the ratio of volatile capital flows (defined to include
cumulative portfolio inflows and short-term debt) to reserves declined
from 146.6 per cent as at end-March 1991 to 36.0 per cent as at end-
March 2004 but increased marginally to 36.8 per cent as at end-March
2005.

8. INVESTMENT PATTERN AND EARNINGS FROM FOREIGN

EXCHANGE RESERVES

The foreign exchange reserves are invested in multi-currency, multi-

market portfolios as per the existing norms, which are similar to
international practices in this regard. As at end-March 2005, out of the
total foreign currency assets of US$ 135.6 billion, US$ 36.8 billion was
invested in securities, US $ 65.1 billion was deposited with other central
banks & BIS and US$ 33.6 billion was in the form of deposits with foreign
commercial banks.

DEPLOYMENT PATTERN OF FOREIGN EXCHANGE RESERVES (US

$ Million)

As on March As on September
31, 2004 30, 2004
(1) Foreign Currency Assets 107,448 135,571
(a)Securities 35,024 36,819
(b) Deposits with other central banks & BIS 45,877 65,127
(c) Deposits with foreign commercial banks 26,547 33,625
(2) Special Drawing Rights 2 5
(3) Gold (including gold deposits) 4,198 4,500
(4) Reserve Tranche Position 1,311 1,438
(5) Total Foreign Exchange Reserves 112,959 141,514

During the year 2003-04 (July-June), the return on foreign currency

assets and gold, after accounting for depreciation, decreased to 2.1 per
cent from 3.1 per cent during 2002-03, mainly because of lower money
market interest rates in major countries and a fall in prices of securities
due to rise in longer term yields.
 Indian Forex reserve for 5years

Item As on Sep. 21, 2007 As on Sep. 19, 2008 As on Sep. 18, 2009 As on Sep. 17, 2010
As on Sep. 15, 2006
Rs. Crore US$ Mn. Rs. Crore US$ Mn. Rs. Crore US$ Mn.
2 3 Rs. Crore US$ Mn. ` Crore US$ Mn.
1 2 3 2 3 2 3
Total Reserves 7,63,924 1,65,542 9,41,247 235,891 13,50,213 291,972 13,53,607 280,770 13,24,937 287,734
(a) Foreign Currency Assets + 7,29,958 1,58,239 9,11,315 228,572 13,09,979 282,811 12,73,653 264,353 11,98,657 260,748
(b) Gold $ 30,436 6,538 28,186 6,881 38,064 8,692 48,041 9,828 94,199 20,008
(c) SDRs @ 6 1 8 2 17 4 25,336 5,224 23,105 5,026
(d) Reserve Position in the IMF** 3,524 764 1,738 436 2,153 465 6,577 1,365 8,976 1,952

Item
VARIATION OF FOREX RESERVE IN 5
YEARS
Year 2006 year 2007 Year2008 Year2009 Year 2010
Rs. US$ rs US$ Rs. US$ Rs. US$ Mn. US$
1 Crore Mn. crores Mn Crore Mn. Crore ` Crore Mn.
1,31,14 21,320 1,76,02 69,40 4,08,96 56,08 3,394 -11,202
Total Reserves 1 –28,670 6,964
(a) Foreign Currency 1,23,48 19,996 1,80,06 69,39 3,98,66 54,23 -36,32 -18,458
Assets + –74,996 –3,605
(b) Gold $ 10,465 2,003 –2,250 343 9,878 1,811 9,977 1,136 46,158 10,180
(c) SDRs @ –13 –3 2 1 9 2 25,31 5,220 –2,231 –198
(d) Reserve Position –2,792 –676 –1,790 –332 415 29 4,424 900
in the IMF** 2,399 587
CONCLUSIO














 





































 







 




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BIBLIOGRAPHY

Forex News (www.forexnews.com/)

Real Time Forex News (www.realtimeforex.com/index.php?page=51)

Bloomberg- Business & Financial news

Forex News & Insight (www.forexLive.com)

ForexFocusDaily.com (www.forexfocusdaily.com/)