The news at the end of the last week was not good. Inflation has inched closer to 12%. Industrial growth has slumped to a six-year low. And credit rating agency Standard and Poor’s said that Indian debt could be pushed back to junk status if the government fails to deal with the “triple whammy of rising inflation and worsening fiscal and current account deficits”.
These are tough times, an inconvenient truth that even the finance minister has now accepted. The more important issue is what the government is planning to do about it.
A combination of easy money and fiscal profligacy have fanned the inflation fire. High oil prices and financial instability in the West have not helped either.
We believe that unless economic growth collapses — which seems unlikely right now — the government and the central bank should focus more on economic stability.
Given the dark clouds on the horizon, the foreign exchange hoard with the Reserve Bank of India (RBI) can be an important stabilizer as well as useful insurance against financial instability.
The very latest data does not offer much comfort. RBI said on Friday that foreign exchange reserves had dropped by $3.39 billion in the week to 4 July.
That is more a warning than a cause for immediate worry.
India’s forex reserves at the beginning of July were $308.40 billion, some $30 billion more than what was available in the first week of 2008. RBI has been cautious about the way it has built up this hoard; not too long ago, it was under pressure to use part of the “excess” reserves to set up a sovereign wealth fund or even use the dollars to help Indian companies buy competitors abroad.
India is likely to have a capital account surplus this year as well, unless the world economy topples into a 1997-style crisis. So, we do not expect a run on the bank. But the era of rapidly growing reserves is over.
A widening current account deficit, continued equity market sales by foreign investors and the need to sell dollars to smoothen the fall in the rupee will mean India’s foreign exchange reserves will be tested in the months ahead.
Is the era of rapidly growing foreign exchange reserves in India over? Write to us at email@example.com