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In early June, India’s foreign exchange reserves crossed $600 billion for the first time. They stood at $608.1 billion as of 11 June, with foreign currency reserves accounting for $563.5 billion. Gold reserves of $38.1 billion accounted for much of the rest.

This has led to a lot of self-patting on the back, given that India now has the fifth largest foreign exchange reserves in the world. Our gold reserves of 695.3 tonnes are the tenth largest.

But there is much more to foreign exchange reserves than just their absolute number. As the Reserve Bank of India (RBI) points out in its latest State of the Economy report: “In terms of projected imports for 2021-22, the current level of reserves provides cover for less than 15 months, which is lower than for other major reserve holders—Switzerland (39 months); Japan (22 months); Russia (20 months); and China (16 months)." We are clearly not top of the charts when it comes to import cover.

Other than imports, which need to be paid for regularly, one also needs to look at external debt, which has to be repaid in the foreign currency in which it was borrowed. As of December 2020, the latest data available, total external debt stood at $563.5 billion. This was 104% of our foreign currency assets of $541.6 billion as of 1 January 2021.

The other important metric to look at is the net international investment position, which is basically the difference between a country’s stock of foreign assets vis-a-vis foreigners’ stock of the country’s assets. In India’s case, the net international investment position as of December 2020 was (-) $340.5 billion or (-) 12.9% of the GDP. The net international investment position was (-) $425.1 billion in December 2019.

A major reason for the narrowing of our net international investment position has been an increase in foreign exchange reserves. They had stood at $459.9 billion in December 2019 and jumped to $585.8 billion by December 2020. Foreign exchange reserves get counted as assets when it comes to determining the net international investment position.

Why have foreign exchange reserves been going up? Our imports of goods in 2020-21 fell to $392.2 billion from $474.2 billion in 2019-20. This was primarily on account of a fall in consumer demand, including for oil, as a result of the covid pandemic. Other activities on which foreign currency is spent, like personal and business foreign travel, foreign education, etc., also came down during the course of the year. The point being that Indian demand for foreign currency declined.

Foreign currency coming into India also fell, but not at the same pace. Take goods exports, which fell from $313.2 billion to $290 billion. Or take remittances, which primarily includes money sent home by overseas workers; they fell marginally from $56.9 billion during April to December 2019 to $54.7 billion during April to December 2020.

On account of the covid pandemic, India spent less foreign currency than it would normally have. At the same time, it earned less foreign currency, but that fall wasn’t as much as the country’s fall in demand. This added to our foreign exchange reserves.

It is also worth remembering that we live in an era of easy money and hence foreign money keeps coming to India in search of a higher return to be invested in stocks. In 2020-21, foreign portfolio investors invested an all-time high of $37 billion in India in order to buy stocks. This also added to the foreign exchange reserves.

Such a situation is not going to prevail forever. Hence, we should be careful about the inferences we make on our foreign exchange reserves, given that there are enough foreign liabilities that need to be paid for.

One of the suggestions made keeping in mind our high foreign exchange reserves is that these reserves should be spent to give a stimulus to the economy. The idea being that with private consumption so badly impacted, this extra spending would help boost economic activity in the country.

But how do you go about doing this? RBI buys foreign currency by selling rupees. Hence, the foreign currency it acquires resides as an asset on its balance sheet. The rupees sold are a liability. In this scenario, how do you print money against foreign currency reserves and spend it?

The only way to raise money here is to borrow against foreign exchange reserves, like the country did in 1991 by mortgaging gold.

Sanjaya Baru recounts this in his book, 1991: How P.V. Narasimha Rao Made History. When the then cabinet secretary Naresh Chandra told Prime Minister Chandra Shekhar about having to mortgage gold to pay for imports, the prime minister was furious: “I do not want to go down in history as the man who sold gold for buying oil."

To which Naresh Chandra replied: “But, sir … you have to choose between going down in history as the prime minister who mortgaged gold or as the prime minister who defaulted." Chandra Shekhar wasn’t left with an option.

Hence, using foreign exchange reserves to generate funds is done only in times of an extreme emergency. While the Indian economy is in a weak state right now, we are clearly not facing a financial emergency.

Vivek Kaul is the author of ‘Bad Money’.

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