Foreign exchange

If you were at a foreign exchange counter at any Indian airport last week, the quoted rates would have shocked you: a little more than Rs 45 if you were to sell them and more than Rs 53 if you wanted to buy. The spread of nearly 18 per cent between the two prices is shocking; usually it ranges around 5 per cent, which is already higher than what a bank would charge you.

Businessworld
Srikanth Srinivas

But exchange rate volatility also raises a set of issues that may have not mattered six months ago. For one thing, no one is certain how much more the rupee will depreciate, and what that will do to corporate India’s prospects.

Second, the spectre of large capital outflows on top of the $12 billion that foreign institutional investors (FIIs) have already taken out of Indian markets raises questions about the quality of the inflows that led to the huge build-up of reserves until March, even May this year.

Third, while India may have the fourth largest reserves in the world, we are also the fifth largest debtor nation — at $221 billion —according to the World Bank’s Global Development Finance 2008 report. Which brings us to an extreme question: in the event of sudden and large reversals, will our current reserves be enough?

Many like Krishnamurthy take heart from the ‘fierce and coordinated’ intervention by central banks around the world, including the Reserve Bank of India (RBI). They point to the fall in oil and commodity prices (the Indian crude oil basket is about $62 a barrel right now), which implies that the trade deficit that has widened sharply in the past two months, will do better.

Foreign exchange reserves

As the global financial crisis deepens, FIIs may end up taking out more than the $12 billion that they have taken out of our stockmarkets so far.

Corporate India has about $62 billion outstanding in external commercial borrowings (ECBs), starting from 2002. Repayment of about 20-25 per cent of which is estimated to fall due this year. That means another $12-15 billion will likely go out in the next few months.

From July 2006 to March 2008, accretion to foreign exchange reserves grew very rapidly; but from April to June 2008, addition dropped alarmingly. Reserves management then was about managing the demand side of capital flows: discouraging them. Now, it is all about managing the supply side of capital — making sure we have enough.

Under the present situation, if another $60 billion — through a combination of ECB repayments and FII sales — were to be taken out, it would absorb all the rupees released by cutting CRR to 3 per cent (Rs 1,80,000 crore) and an unwinding on the market stabilisation scheme (MSS) (about Rs 1,25,000 crore) that the RBI used to mop up excess liquidity.

Before 1990, foreign exchange reserves accounted for 6-8 per cent of GDP for most countries. Today, they account for close to 30 per cent; East Asian economies built them up as insurance against capital flight, with India following suit. And that is now being flight-tested.