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Rising forex reserves causing problems for RBI

By Alok Mukherjee

NEW DELHI, MAY 1. The rising foreign exchange reserves is creating problems for the Reserve Bank of India and bankers and economists fear that if the reserves do cross $150 billion by the end of 2004 — as estimated by the National Council of Applied Economic Research — there could be higher inflation in the coming months. The reserves stood at $117.87 billion at the end of April 23.

The RBI is already under pressure from the exporting community that wants the central bank to arrest the appreciating rupee. With dollar supply being in excess of demand in the market, the exchange rate of dollar-vis-a-vis the rupee has been falling, thereby squeezing exporters' profits and outpricing their products in the international market. But, for the RBI, sucking up dollars would result in higher money supply in the economy which, in turn, could lead to higher inflation. The only way that the RBI can avoid this is to sell the government bonds it holds, but the central bank has almost run out of bonds to sell in the market. An alternative has been created in the form of a Market Stabilisation Scheme, but economists point to the fact that this would be a costly proposition for the Government in the long run.

Neglecting the exporting community's demand for arresting the appreciating rupee would have its own consequences, economists say. Though India's foreign exchange reserves are very high, it was basically the $62-billion export earnings in 2003-04, which went towards financing the import bill of about $75 billion in that year. With imports slated to rise in the coming months because of the anticipated higher economic growth, a fall in exports could widen the trade deficit to unmanageable levels.

Foreign trade data analysed by the NCAER show that the overall export performance decelerated from 20.8 per cent in April-December 2002 to 14.4 per cent in the corresponding period of 2003. The research body, however, feels that the real deceleration appears to be much greater due to a massive hike in the dollar prices of world merchandise trade. The engineering goods category appears to have experienced some acceleration in exports but the worrying feature was the deceleration in exports of textiles and readymade garments to the extent that the dollar values of exports of cotton yarn and fabrics and readymade garments registered negative growth rates.

Another worrying development, according to the NCAER, was the sharp deceleration in India's exports to its largest export destination — the U.S. Exports to the U.S. grew just 1.8 per cent in the first nine months of 2003-04, compared with a 31.5 per cent growth during the corresponding period of 2002-03. The rupee's appreciation vis-a-vis the dollar was causing a major dent in India's exports, the NCAER feels.

The only option before the RBI is to `manage' the inflow of foreign exchange into the Indian economy. While foreign direct investment and foreign institutional investments continue to be on the `encouragement' list, deposits from non-resident Indians (NRIs) are no longer the favourite of the RBI.

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