Change in Sources of growth in Foreign Exchange Reserves in India – An Analytical Perspective Abstract

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Dr. Subhransu Tripathy1 Almost from a position of bankruptcy in the year 1990-91, with a series of reforms the foreign exchange reserves of India only not seen an upsurge, but also under gone a change in its composition. Foreign currency assets both in the pre- economic reforms phase (1980s) and post economic phase has remained the dominant component of the foreign exchange reserves. Components like flow of foreign investment flows, external commercial borrowings, NRI deposits and change in valuation have been the major contributors to the foreign exchange reserves, whereas in 1980s the situations were different. Reduction in short term debt and debt service ratio have and some policy reforms pertaining to NRI deposits have been conducive for reducing volatility in the foreign exchange reserves. The change in the composition of foreign exchange reserves has been the main content of this paper. Also this paper has tried to relate the policy relationships with the growth of foreign exchange in India. Introduction: One of the important manifestations of severe economic crisis of 1991 was deterioration of adequacy of foreign exchange reserves. Import cover of reserves, which fell to a low of 3 weeks of imports at end-December 1990 had resulted in an outflow of Gold reserves, securing loans from IMF to meet the international payment obligation and this had forced India to adopt economic reforms. Adequacy of reserves as per traditional approach is gauged in terms of import cover of 3-4 months. However, in case of emerging market countries like India as suggested by Tarapore committee Report on Capital Account Convertibility: for the measures of adequacy of reserves besides trade based indicators, other relevant money based and debt-based indicators are to be considered. Actually broadening of adequacy measures became imperative because of the change in the profile of capital flows in India in the post economic reform phase. Undoubtedly, since the economic reforms initiated the size, composition and risk profiles of various components of foreign exchange reserves, degree of external economic exposures and types of external economic shocks to which the economy is vulnerable have been changed. On the other hand foreign exchange reserves can not be accumulated indefinitely as excessive reserve holdings leads to increase in sterilization cost. I. Adequacy of Foreign Exchange 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 endDecember 1990, rose to 11.5 months of imports at end-March 2002
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Dr. Subhransu Tripathy, Associate Faculty, Entrepreneurship Development Institute of India, e-mail: dr.subt@gmail.com

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2 per cent at end September 2008 (Half Yearly Report on Foreign Exchange Reserves.3 2. RBI The ratio of short-term debt to the foreign exchange reserves declined from 146.5 67. At end-March 2004.0 56.1 26.2 (Short term debt + portfolio stock) / Reserves In Percentage 146.10 5. Table 1: Adequacy Measures & Risks of Volatility Year Reserves Reserve to Imports In Months 1.5 2.and increased further to 14.2 45.2 per cent at end-March 2008 and then to 20.8 3.9 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 In Million $ 3627 5757 10199 19699 17922 20170 24688 27341 32667 37902 45871 67666 98938 126593 131924 Source: Compiled from handbook on Indian Statistics.6 Reserve to Imports & Debt service payments In Months 1. the ratio further increased to 14.5 per cent as at endMarch 2005 but increased slightly to 12.0 7.2 68. RBI.0 39.7 13.1 11.0 9.4 34.3 10.8 7.9 per cent as at end-March 2006.4 15.5 per cent at end-March 1991 to 12.1 per cent at end-March 2007.0 5. Chart-1 2 . RBI.2 4.4 13.9 36.4 35.4 58.8 5.7 7.1 5.4 months as at end-March 2008 and further to 11.2 months as at end-September 2008 (Half Yearly Report on Foreign Exchange Reserves. which came down to 14. the import cover of reserves was 16.9 6. With broadening the coverage of short-term debt.6 9.4 56.9 13.7 13.8 7. to 15.5 76.8 67.2 months of imports or about five years of debt servicing at end-March 2003.3 5.8 4.2 5.6 7.6 74. 2008-09).9 months.0 4.7 14. 2008-09).

foreign currency reserves and its components are considered for analysis and hence much regarding 3 . The ratio reveals that minimum chance of occurrence of currency crisis as the reserves are comparatively very high.6 per cent as at end-March 1991 to 46. This has made Foreign Exchange Reserves/STED ratio better in last decade as mentioned in a paper by Sanjay Sehgal and Chandan Sharma (2008). sanjay Sehgal & Chandan Sharma (2008) According to debt-based indicator of adequacy measure. The ratio of volatile capital flows (which is defined to include cumulative portfolio inflows and short-term debts) to the reserves declined from 146. The most important limitation of this paper is that only one variable i. On the other hand the paper has attempted to analyze the change in the composition of foreign exchange reserves in the post economic-reform period from various policy regime perspectives. This paper is not dealing with the serious issue like determination of desired level of holdings of foreign currency reserves by India.e.4 per cent at end-March 2008 (Half Yearly Report on Foreign Exchange Reserves. RBI. In India. while foreign currency assets (FCA) have grown around hundred times. Cost and Determinants of International Reserves in India.Source: A Study of Adequacy. Short term external debt (STED) hasn’t increased since 1990-91. it is generally perceived that one country should hold reserves for four to five quarters short term external debt in advance. Adequacy norms are just mentioned to provide basic idea of growth of foreign exchange reserves in India in terms of months of imports and short term debt obligations.2 per cent as at end March 2007 and further the ratio had declined to 45. 2008-09).

Banking capital comprises assets and liabilities of authorized dealers. 2000). Section-II: structure of growth of foreign exchange reserves and Section-III: impact of various policy prescriptions on growth of various components of foreign exchange reserves. however. The flows of foreign exchange reserves as per BoP statistics exclude variation in gold and valuation changes in FCA and SDRs. liquidity aspects and need for a distinction between owned and non-owned reserves. the year-2002-03). (c) Increase other types of capital inflows. quota payments to IMF. In terms of statistics provided in the BoP the foreign exchange reserves: the net of Current Account and Capital Account are the major source of accretion of reserves. a unique definition of foreign exchange reserves is not available as there has been divergence of views in terms of coverage of items. which determine foreign currency reserves has not been attempted. (b) Banking capital. IDA. external assistance. India’s subscriptions to international institutions. The foreign exchange reserves of the country consist of (i) foreign currency assets (ii) gold holdings of the RBI and (iii) Special Drawing Rights (SDRs) and reserve tranche position in the IMF (w.development of a model consisting factors. ownership of assets. or for other purposes (IMF. Foreign exchange reserves are defined as external stock of assets. NRI deposits and movement in balance of foreign central banks and international institutions like. funds raised and held abroad by Indian corporates. banking capital and ‘other capital’ needs further elaboration. portfolio investment. the foreign currency and the securities held by the public including the banks and corporate bodies are not accounted for in the definition of official holdings of international reserves. Major sources of Foreign Exchange inflows into Reserves: Major components such as net of exports-imports. which is available to the country's monetary authorities to cover external payment imbalances or to influence the exchange rate of the domestic currency through intervention in exchange market.f. Section-I Conceptually. maintained with RBI. (d) Short-credit and (e) Valuation changes in reserves. BoP Statistics does not provide some of the components like 4 . However. etc. ADB.e. foreign direct investment. The standard approach for measuring international reserves takes into account the unencumbered international reserve assets of the monetary authority. World Bank. The paper comprises three broad sections such as section-I: Conceptual issues of Foreign Exchange reserves. but other sources like investment income. IFC. external commercial borrowings are given in BoP of the country are quite clear. Reconciling with this fact RBI in a report mentioned that major sources of increase foreign exchange reserves have been: (a) investment. ‘Other Capital’ is a residual item and broadly includes delayed exports receipts.

etc. the level of foreign exchange reserves has steadily increased from US $ 5. which has increased mainly due to rise in foreign investment inflow. but the foreign exchange reserves are denominated and expressed in US dollar only.72 billion by March 2008.17 billion by end-March 2007 and further to US $ 309. Japanese yen. US dollar. such as. external commercial borrowings and bank capital. Pound sterling.8 billion as at endMarch 1991 to US $ 199. In terms of currencies US dollar and Euro have been traditionally intervention currencies for the monetary authority. Euro. and is valued in terms of US dollars.change in valuation of foreign exchange and Gold reserves for compiling total foreign exchange reserves. FCA (Foreign Currency Assets): FCAs are maintained as a multicurrency portfolio comprising major currencies. Chart-3: Growth Rate of Foreign Exchange Reserves 5 . The trend in reserves is largely governed by the foreign currency assets component. Chart-2: Three Main components of Foreign exchange Reserves 200000 400000 600000 800000 0 18 90 Foreign currency assets/Gold/SDR 18 95 19 90 F r ig c re c a s t oe n ur n y s es SR D Ya er 19 95 20 00 Gld o 20 05 Section –II Level and Composition of the Reserves: In over one and half decades of economic reforms.

0 20. 6 .0 140. commercial borrowings and non-resident Indian deposits (Chopra and others 1995).0 60.0 80.indiastat.0 1992-93 -40.com In the post economic reforms on the commencement of a series of economic reforms in the areas like foreign direct Investment. etc. NRI deposits.0 100. exchange rate convertibility.G rowth Rate of Foreign Exchange Simple Grwoth Rate 120 100 80 60 40 20 0 4 6 8 2 4 2 0 6 91 -9 93 -9 95 -9 97 -9 99 -0 01 -0 03 -0 05 -0 07 -0 8 Series1 -20 19 19 19 19 19 20 20 20 Y ear Source: www.0 0.0 Simple Grwoth Rate 20 S eries1 1995-96 1998-99 2001-02 2004-05 2007-08 Y ear Source: www.Indiastat.0 40. Foreign portfolio investment. But the compositions of foreign currency assets have under gone changes tremendously in the post economic reforms phase. including sterilization policy the quantum.com Foreign currency assets have remained dominant component of foreign exchange reserves even before the initiation of economic reforms in post 1990s. Chart-4: Growth Rate of Foreign Currency Assets G row R of F A th ate C 160. In the preeconomic reforms phase (1980s) capital flows to India predominantly consisted of aid flows.0 -20.0 120. compositions and volatility of reserves have changed significantly. norms of external commercial borrowing. foreign exchange management.

which stood at US $17.0 7 .com Accretion in Foreign Currency Assets as reflected by BoP. as it has been mostly in a deficit form and it is the surplus in the capital account. rose to US $128 billion in 2006- 10 0 . But India’s exports. The following graph gives an over all trend of foreign currency assets as a dominant component of foreign currency reserves. Chart-6: Trend in the Foreign Currency Assets in the post Economic phase 10 2 .5 : Foreign currency Assets as a % of total Reserves in the post & Pre Economic reforms phase: 18 95 19 90 Ya er 19 95 20 00 20 05 Foreign currency assets as a proportion of total foreign currency Reserves is not only high. Since the beginning of the economic reforms it has seen an upward trend. which has been playing a major role in the accretion of foreign currency reserves.0 Source: www. has not been supported by Current account. but also instability in the foreign exchange reserves are mostly caused by this component.9 billion in 1991-92.Indiastat.FCA % of Total Forex Reserves 40 18 90 60 80 100 Chart.

4 billion in 2006-07.21 billion at the end of March 2007. From the table given below one can ascertain that FDI was highest 13. A glance at the composition of the capital account balance reveals that by the year 2006-07. the volatile flow (38. it is clear that share of foreign investment in the foreign currency assets has increased faster during first half of economic reforms (between 1990-91 to 1997-98).37 billion at the end of March 1991 to US $43. The ratio of volatile capital flows including cumulative portfolio inflows and short-term debt as a proportion of reserves has fluctuated as it was 35. The increase in foreign exchange reserves is caused by an increase in the annual quantum of foreign direct investment from US $129 million in 1991-92 to US $ 8961 million in 2005-06 and as per provisional figure it is reached at US $ 32435 million by the year 2007-08. when reserves amounted to $199. In the later part of this paper percentage of growth of different components of foreign currency assets. Net invisible inflows grew from US $1. But upsurge of import bill has nullified the gain in foreign exchange reserves on account of current account balance. major components in terms of US $ million were as follows. external commercial borrowings (22767).2 per cent) at $76 billion and this was certainly not insignificant. Of this. from a very low during the early years of reforms. One of the important concerns is that on the rise of stock market the investment by FIIs also appreciates and keeping foreign exchange rate constant one can state that the outflow of forex will be high incase the FIIs withdraw from the stock market and this kind of volatility is not addressed by monetary authority. when foreign exchange reserves data are published. The outstanding NRI deposits grew from US $15.3 billion in March 2006. the major chunk is FII investment of $52 billion.6 billion to US $53. It is clear from the above account that foreign investment and external commercial borrowing including short term have been major components that has helped boost the reserves. when decision was taken to allow FII in the stock market. 43. Thus. foreign investment share in the foreign currency assets has increased tremendously.7 percent during 1995-96.2 per cent as at end-March 2004.7 % in the year 1997-98 and 8 .4 per cent (end-March 2006) and 38. Foreign investment (15541). From the table -2. at end-March 2007. 36. there has been strong increase in FDI flows to India. which have been complied on the basis of BoP statistics have been mentioned. NRI deposits (4321). external assistance (1787). Particularly since the year 1993-94. and other items (332).2 per cent end-March 2007. It touched an all time high of about 28.2 billion. which enters the stock market and can leave easily.07. Depending on relaxations of norms of allowing foreign direct investment. Foreign Institutional Investors (FIIs) are allowed to make portfolio investments in India since 1993.9 per cent (end-March 2005). The cumulative FIIs investments increased substantially from US $827 million in December 1993 to US $45.

5 6. This result is not a surprise too as FII flows are quite volatile as compare to any other components of foreign currency assets.8 83.9 6.8 23.0 4. Foreign currency assets are mostly accumulated through net of current account and capital account and on account of change in valuation.2 20.9 3.7 18.2 16 8.0 1.3 12.7 FDI as % of FCA 4.7 8.6 11.9 8.06 12.fluctuations in the FDI as a component of FCA also is quite clearly revealed.6 6.1 10.4 8.8 46.6 7.6 12.5 10.0 -0.1 3.2 11.3 0.6 2.7 8.3 14. But the fluctuation in the FII component is stronger as compare to the FDI flow.0 7.2 8.7 28. Table-2: Proportion of Foreign Investment as % of Foreign Currency Assets Year 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99* 1999-00* 2000-01* 2001-02* 2002-03* 2003-04* 2004-05* 2005-06* 2006-07*P 2007-08*P C.1 14.3 4.4 20.8 7.4 14.6 24. The following table presents calculated average growth rate of major components of foreign currency assets over a period of 17 years in the post economic phase.V.4 10.3 2.6 Computed from the Handbook of Statistics on the Indian Economy. Table -3: Growth of Key Components of Foreign Currency Assets Key Components of Foreign Currency Assets Current account Net Net Capital Account of Which I.7 49.7 FII % of FCA 0.4 37.0 4.2 12.8 15.6 3.4 16.3 6.0 4. RBI 2008-09.6 9.1 14. Foreign 1990-91 2006-07 Calculated Average Growth Rate over the period : 199091 to 2006-07 in % 0.7 27.6 13. On the average foreign investment has experienced the highest growth as it has increased 37% per annum during the period mention above.0 -9680 7188 103 -9766 46372 15541 9 . Foreign Investment Flow % of FCA 4.7 27.8 17.

7 II. Net Loans b.25 -12. Other Capital 132 Source: Economic Survey 2007-08 4321 -162 7724 6.a.8 1075 2210 682 6612 1787 1913 13. Net Commercial Borrowings b. Net Banking 97 6 5533 2248 21991 7004 24534 16457 40. foreign institutional investments and foreign direct investments as percentages of foreign currency assets and reveal that foreign investment was virtually nil in the year 1998-99. Debt service -1193 V.73 28.Investments a. Net NonResident 1537 Deposits IV. Components like Net external assistance and debt services ratio both have gone down in terms of average growth rate and this is a very healthy symptom.7 -11.i.ii.i. FDI a.0 55. Short term b.ii.0 6. The following chart -7.96 Again further sub-division of components reveals that average growth rate of foreign portfolio has been higher than the foreign direct investment and it has experienced the highest growth rate too. Foreign Investm ent as % of Foreign Curren 35 30 25 % share 20 15 5 0 1 3 5 10 Chart-7: Foreign Investments as % of Foreign Currency Assets 10 *P 9* 1* 3* 5* 7 .0 9. FPI II.ii. presents Foreign investments. Net External Assistance III.

2% as at end-March 2004.3 billion (RBI Report 2007: Salient Points) Stationary Test of Foreign Exchange Reserve Data: The Dickey Fuller Test for Unit root in Foreign Exchange reserves (monthly) was carried out to look into the stationary of the time series foreign exchange reserve data. During 2003-04. However. the FDI flows exceeded the FPI flows. In 1991. The ratio registered a moderate increase and stood at 36. capital account balance of $212. It was at 43. India was forced by the International Monetary Fund to embark on market liberalization and economic reforms to attract foreign direct investment (henceforth FDI) to avert an impending economic crisis. Since then the country has witnessed a steady influx of FDI inflows. Hence.6% at the end of March 2005. From the result presented below. with the expansion of FPI flows.174 and it is exceeded the MacKinnon critical values at 1%. The rise in FPI flows had been particularly sharp since 2003-04. The increase in reserves from $5. The ratio of volatile capital flows (which includes cumulative portfolio inflows and short term debt) to reserves dropped from 146.6% as at end-March 1991 to 35.1 billion. 2007-08 From 1993-94 to 1997-98. But as per inference principle for a stationery series the coefficient of regression of lagged variable must be in the range of -1 to +1. then yearly of course will follow a stationery path. 5% and 10% critical levels. the coefficient of regression was slightly higher than 1.Source: Economic survey.2 billion as at end-March 2007 has been made possible via the following components of the balance of payments accumulated over the 16 year period: Current account balance of $ -34.2% at the end of March 2006. when lagged monthly foreign exchange reserve data was regressed as an independent variable with monthly data.130 millions in 2001-02 to experience a slight dip in 2003-04 only to recover and settle at $5. an increasing level of foreign exchange reserves is required to be kept liquid to ward off any sudden shocks of capital flight. The inflows reached its record level of $6.526 millions in 2004-05.4%.8 billion as at end-March 1991 to $199. It stood at 68. But. Table-4: Augmented Dickey-Fuller test for unit root : Exchange Reserve Month wise (217 Months ) Interpolated Dickey-Fuller Test 1% Critical 5% Critical 10% Critical Statistic Value Value Value 11 Foreign . subsequently the trend had reversed. their share of total foreign investment inflows was at 79.2 billion and valuation change of $15.2% in 2005-06. FPI flows are considered less stable than FDI flows. it can be inferred that the test statistics is 4. So the time series monthly data of foreign currency reserves is stationery in nature and accordingly one may conclude that if monthly data series is stationary in nature.

97094 26.Squared = 0. Government aid receipts also add to the foreign exchange reserves. Table-5: Sources of Accretion to Foreign Exchange Reserves since 1991 Items 1991-92 to 2007-08 September 2008) In US $ Billion Reserve outstanding as on 5.8 Foreign Investment of Which 160.0696496 17. Std.8 (i) FDI 72.28 0.434 -3.1685941 .66 0.1077864 -1.98808 30.9 (Up to A.4338 155.08 0.988 4531.1201058 . t P>|t| [95% Conf. B. 2008.2628725 Trend: -22.89636 -0.38 0.001 -3.0717199 -0.174 -4.0132 Accretion of Foreign Exchange Reserves: Accretion to foreign exchange reserves arise out of purchases by the RBI from Authorized Dealers and from the income on foreign exchange assets deployed.678 -2954.202 -.0746053 L3 -.0271949 .394 -75.0462 cons: 788.000 1.9915 -1.0226609 .II. Interval] L1 1.081 0.27 0. t P>|t| [95% Conf.988 Coef.705 -.1 Capital Account Net (a to e) 341. Std.1379007 . India’s external sector has been characterized by an overall surplus in the balance of payments (BoP) since 1996-97 resulting in substantial accretions to foreign exchange reserves.013516 .8 March 1991 Current Account Balance -74. Err.134 * MacKinnon approximate p-value for Z(t) = 1.811 -----------------------------------------------------------------------------Foreign Exchanger Reserves Lagged Variable Regression Variable :Foreign Exchange Reserves Lagged R.207 -712.052003 1.4119 1899. B.099 -. Err.0724276 1.3504067 . 12 . (II) Other Capital Account (III External Commercial Borrowings including Short term debt (IV) NRI Deposits (V) External Assistance and (VI) Valuation in Change.0061351 4.17 0.85 0.000 .0256094 .Z(t) 4. a. Accretion of foreign exchange as clear from the table-5. If one ranks the sources of accretion of foreign exchange since 1991-92 to till September. has been negatively impacted from current account balance and mainly taken place owing to increase in the foreign investment.1142043 _cons -278.7103 219.I. Interval] L1: .18932 .326638 L2 -.0000 Coef.0377027 LD: .42 0. the outcomes according to descending order are: (i) Foreign Investment (FPI & FDI).

Gold reserve component has not been included in RBI report on accretion of foreign exchange reserves and certain policy determined components like SDR and Reserve tranche also need a separate discussion. c. Among the three components of the foreign exchange reserves. an increase of US$ 3395 million in 1991-92 as against a decline of US$ 1132 million in 1990-91. which were under taken under certain external shocks as well as domestic situations. in spite of recourse to IMF resources as discussed earlier. Cumulative net FII investments increased from US$ 1 million at end-March 1993 to US$ 66. Foreign exchange reserves stood at US$ 9220 million at the end of March 1992. During the earlier phase of foreign exchange reserve related reforms the growth of forex reserves had been high. foreign currency assets stood at USS 5631 million at the end of March 1992.8 16. Foreign currency assets reached US$ 6. have shown significant increase over the subsequent years. The decline of foreign currency assets during 1992-93. FII investments in the Indian capital market.4 billion in 2007-08.0 30. In short the accretion in foreign exchange reserves in the post economic reforms phase has taken place primarily because of foreign investments flows.6 billion at end-March 2008.9 billion in the middle of July 1992 and stood at US$ 5096 million as on 5 February 1993 showing a decline of US$ 535 million over the end-March level. e.7 billion as at end-March 2008.b.III. B.9 60. which have impacted foreign exchange reserve piling in India. d.0 billion at end-March 1991 to US$ 43.1 73. was mainly due to a substantial increase in imports as industry recovered and replenished its inventories.2 12.8 286. There are many sector and component specific level reforms. 2008 An analysis of the sources of reserves accretion during the entire reform period from 1991 onwards reveals that the increase in foreign exchange reserves has been facilitated by an increase in net foreign direct investment (FDI) from US $ 129 million in 1991-92 to US$ 15. Section-III The new balance of payments adjustment strategy adopted since July 1991 has resulted in a considerable improvement in reserves during 1991-92 and 1992-93. an increase of US$ 3386 million over the end-March 1991 level. 13 . (ii) FII NRI Deposit External Assistance External Commercial Borrowings Others of Capital Account Valuation Change Total (A+BI + BII+BIII) 60. which commenced in January 1993.3 Source: RBI Report on Foreign Exchange. Outstanding NRI deposits increased from US$ 14.

which stood at US$ 5. Indonesia. Now due to upsurge in foreign currency assets. SDR 61 million was made available under the FTP to countries like Uruguay. Turkey and Pakistan. During 2007-08.1 billion from US$141.1 billion.0 billion by end-March 2000. There were 21 repurchase transactions during the period from November 2005 to December 2008 totaling SDR 772 million received from 7 countries. The growth continued in the second half of the 1990s with the reserves touching the level of US$ 38. With the US dollar appreciating vis-a-vis other major currencies. For earlier periods gold is spite of a deficit in the current account. SDR 317 million was made available to countries like Bangladesh. Ukraine and Moldova. Thus. 1990 gold is revalued close to international market price at the end of every month. there was a valuation loss of US$5.6 billion by end March 2006.Effective October 17.2 billion by end-March 2007 and further to US$ 309. increased gradually to US$ 25. the total stock of foreign currency assets went up by US$26.1 billion (on BOP basis) during 2004-05. Haiti. US $ 151. during 2005-06. gold has a very minimal consideration so far as external obligations are concerned. Thus. viz. Gold revaluation had also impacted the reserve position of India. 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. International Monetary Fund (IMF) designated India as a creditor under its Financial Transaction Plan (FTP) in February 2003. SDR 34 million was made available to Turkey and Uruguay. US$ 199. The continuance of the robust net capital inflows not only helped finance the rising current account deficits seamlessly. Subsequently.0 billion on the existing stock of foreign exchange reserves. but also resulted in further accretion to foreign exchange reserves. During May-June 2005. Brazil. the reserves rose to US$ 113. Algeria. During 2005-06. the total purchase transactions amounted to SDR 810 million as at the end of December 2008.5 billion at end-March 2005 to 14 .0 billion by end-March 2004.7 billion by end-March 2008. During 2004-05. India was included in repurchase transactions of the FTP since November 2005. accretion of such reserves through the BoP was US$15. It may be mentioned that foreign exchange reserve data prior to 200203 do not include the Reserve Tranche Position (RTP) in the IMF. Dominican Republic and Sri Lanka. US$ 141. Turkey. The reserves.3 billion by end September 2008.8 billion at end-March 1991. In December 2003. foreign exchange reserves rose by US$10.. Thereafter.5 billion by endMarch 2005.2 billion by end-March 1995. the reserves declined to US $ 286. Uruguay. SDR 43 million was made available to Indonesia under the FTP. In terms of this arrangement.

foreign institutional investors are allowed also invest in government securities  By February 1993. and the India Millennium Bonds in October 2000 yielded $5. during April-September 2006. with rising reserves.5 billion due to the reason of surge in Oil price by three times in a single year 2000. soon after. Further during 1996-1997.6 billion. India adopted a unified.US$151. The policy measures which have profound impact on accumulation of reserves besides interventions of RBI’s sterilization measures are Broad economic reforms measures like abolition Foreign exchange regulation act and increase in foreign equity participation up to 51 % in 34 high priority industries  In March 1992. India moved into current account convertibility in August 1994 and the termination of RBI’s rates in 1995  India took preventive steps to maintain liquidity by issuing bonds to Non-Resident Indians: the Resurgent India Bonds in August 1998 (in response to the 1998 nuclear sanctions) raised $4. a dual exchange rate regime--the liberalized exchange rate management system (LERMS)--was introduced and the country moved to a new system under which 40 percent of the receipts or remittances of exporters were convertible at a fixed rate while the rest was convertible at the market rate. foreign exchange reserves rose by US$13.7 billion from US$151. market-determined exchange rate. In the first half of 2006-07. foreign institutional investors are allowed to invest in the secondary market and. accretion of reserves through the BoP was US$8. Thus. With other major currencies appreciating vis-a-vis the US dollar.1 billion on the existing stock of foreign exchange reserves.6 billion at end-March 2006. Besides the policy measures appreciation of depreciation of Rupee Vis a vis major intervention currency has a significant impact on Foreign exchange reserves.2 billion.  In September 1992. Table-7: Policy Implications & Growth in Foreign Exchange Reserves Years 1980-81 to Foreign Exchange in Million $ Foreign Exchange Growth Model1 Constant Growth Rate in % per Year 15.6 billion at end-March 2006 to US$165.3 billion at end-September 2006.7 Policy Implications Growth rate 15 . in the primary market as well and India became one of the first emerging economies to open its equity market to portfolio investments. there was a valuation gain of US$5.

FII in Stock Market In the post Foreign Exchange Reforms: LERMS.7 combining pre & Post Economic Reforms Growth rate combining pre & Post Economic Reforms Pre-Reforms Phase (Except FDI up to 51% allowed in the Year 1990-91) Pre-Reforms Phase (Except FDI up to 51% allowed in the Year 1990-91) In the post Foreign Exchange Reforms: LERMS. FII in Stock Market Full Convertibility Allowed in Current Account from the year 1995-96 (September1995) Full Convertibility Allowed in Current Account from the year 1995-96 (September1995) 1.2007-08 1980-81 to 2007-08 1980-81 to 1992-93 Reserves Foreign Currency Assets Foreign Exchange Reserves Growth Model Constant Growth Model Constant Growth Model Constant Growth Model Constant Growth Model 16.7 1995-96 to 2007-08 Foreign Currency Assets Constant Growth Model 23.1 1980-81 to 1992-93 Foreign Currency Assets 3.3 1993-94 to 2007-08 Foreign Currency Assets Constant Growth Model 21. India adopted Article VIII of the IMF and thus established current account convertibility and has not been implemented capital account convertibility so far and It is possible that 16 .7 1995-96 to 2007-08 Foreign Exchange Reserves 22.4 7. To Estimate Growth Rate Log-Lin Model has been used : Ln Yt = β 1 + β 2 t Compiled by the author from data source: RBI hand book on Indian statistics On 20th of August 1994.8 1993-94 to 2007-08 Foreign Exchange Reserves 20.

Slow progress towards capital account convertibility is a symbol of cautious approach to make the economy resilience towards external shocks. India was saved from being affected from Asian crisis because of the absence of capital account convertibility and because of the successful policy to reduce short-term debt. which have been quite helpful in reducing volatility in the post economic reforms phase. 17 . Various policies on NRI deposits and liberalization in gold imports are having been very helpful in this regard.if the Asian financial crisis of 1997-98 had not occurred then India may have introduced capital account convertibility much earlier. Bank flows also have been promoted by taking appropriate measures for the business of foreign banks in India. Other major changes. Convertibility on all deposit schemes for non-resident Indians was introduced in March 2002. gold etc.000 by resident Indians annually. attractiveness of such flows to NRIs has been further reduced by the introduction of a 10 percent tax on interest on NR external deposits. For example in 2004. The RBI towards the end of January 2004 issued a notification that allows remittances abroad of upto US$ 25. through illegal channels. Conclusion: Policy measures pertaining to Foreign exchange flow not only helped in accumulating a comfortable foreign exchange reserves in India. According to the 2004 budget. However. are less dependence on short term debt ratio and measures regarding NRI deposits. The diversification of composition of foreign exchange reserves may get diluted once India adopts capital account convertibility. The interest rate differentials will definitely work in favour of arbitrage and ECB flows to India. but the noninsulation of Indian economy from current international financial crisis again has led to for further exploration of foreign exchange reserve availability and readiness for external shocks. RBI reduced the incentive for NRIs to benefit from interest arbitrage by removing the margin they enjoyed over LIBOR. it has also facilitated in blocking the flow of foreign remittances. Technically. it is easy to state that the foreign exchange reserves of India is beyond the limits of adequacy norms.

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