Article

Return of the Forex Blues

Pramit Pal Chaudhuri January 10, 2012

Twenty years later, and New Delhi is once again quietly fretting about its foreign exchange reserves. There has been a whole raft of policies in the past few months designed to buttress India’s dollar reserves. Foreign investors can buy more Indian sovereign debt. NRIs have been given more incentives to remit money. The central bank has tried to squeeze speculative trading on the rupee. And, of course, it initially refused to support the rupee as it began to fall.

Why? Because India’s foreign exchange reserves are starting to droop. They aren’t in freefall, but the gradient isn’t great. On October 14 they were $317 billion and by November 25 they were down to $304 billion.

What probably worries the Reserve Bank of India most is that they don’t see where new dollars are going to come from. India has four main sources of foreign exchange: exports, foreign institutional investments, foreign direct investment and remittances. The first and second are negatives right now. Foreign direct investment has plateaued off and is trickling in. Remittances are going strong – some $40 to 50 billions worth.

But given the country’s import bill and so on, remittances alone are not enough. There are other complications, like the fact that in the coming six months until June 2012 the country also has to pay off about $100 billion in foreign debt. There’s also a lot of external commercial borrowing by various Indian firms that will be due.

All that is for the eggheads. The point is that the RBI is worried enough that it is refusing to spend foreign exchange on pretty much anything, treating its dollar holdings like a miser’s hoard. It is doggedly holding on to them while trying to suck in every dollar it can find from overseas.

This may have influenced the foreign direct investment in retail decision, at least the hurriedness with which it was announced. The decision would affect sentiment but it would’nt bring in dollars for a few more years. Ultimately, the foreign exchange position would change for the better if the market had greater confidence in the Indian political system and its corporate sector and if the rupee had not been allowed to yo-yo. This confidence will have to be rebuilt over the next several months.

Don’t hold your breath. The polity will be paralysed until the Uttar Pradesh elections sometime in the spring. The corporate sector is sitting on over $500 billion in cash reserves but won’t spend until they get a clear idea of the lay of the land. But foreign institutional investors will probably calm down somewhat once their new fiscal year begins in January.

There are pretty good grounds for arguing that the central bank got taken for a ride by exporters who declined to repatriate dollar earnings because they concluded the rupee would fall – giving them a windfall profit when the currency did nosedive. If so, those dollars might suddenly start to come in – note the rising discrepancy between central bank figures for export earnings and those of the commerce department.

But it would also be nice if, on the external side, the Europeans got their act together. That would make the Reserve Bank more willing to cut interest rates (at least that’s my view), and then growth would start to make a comeback.

In the meantime, India will once again be keeping an eagle-eye on its foreign exchange kitty. It’s not yet time to put the family silver up for auction, but the margin for error is a lot less right now.