An embarrassment of riches

India''s forex reserve
25 December 2003

Uday Chatterjee
25 December 2003

Mumbai: In 1990, India's foreign exchange (forex) reserves dipped to an all-time low. India had forex reserves to meet the requirements of only three weeks of imports. To overcome this embarrassing situation, the government had to, at the stealth of midnight, cargo tonnes of gold in a chartered plane to London, pledge the gold with the Bank of England and obtain forex.

Later, with prudent management of forex, reserves improved and the government got the pledged gold back. India's forex reserves have been increasing ever since and during the last two years, there has been a deluge of foreign money pouring into the country.

Come January 2004, the reserves will hit the landmark 100-billion dollars mark, a situation far different from 1990. Compared to 1990, the reserve levels are at the other end of the spectrum, which actually could be an embarrassment of riches.

First let us take a look at how forex reserves are created and why they are necessary. An exporter like say Wipro provides software services to companies in the US and paid in dollars, which are now available in the Indian market. These dollars can now be used for imports or for repaying foreign debts like loans from the World Bank and other agencies.

The Reserve Bank of India (RBI), which is the country's central bank, buys dollars from the Indian market and builds up reserves which is in fact an inventory of the currencies. This inventory needs to be built up as a safeguard to ensure that a 1990-type situation does not arise again.