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Indian Economy

INDIA’S FOREX RESERVE SURGE TO AN ALL-TIME HIGH: A CRITICAL ANALYSIS

The article is authored by Saharshrarchi Uma Pandey, 3rd year student at Maharashtra National Law University, Nagpur.

Picture Credit: – livemint.com

India is the fifth largest economy with a Nominal GDP of $3 Trillion. Coincidentally, it is also the Fifth largest holder of the Forex Reserve in the world.[i] In light of the same, The Indian Foreign Exchange Reserves held and managed by the Reserve Bank of India have recently increased by USD 4.34 billion to a record all-time high of USD 581 billion, for the week that ended on April 9, 2021.[ii]

WHAT IS FOREX RESERVE?

Established in the post World War II era, The International Monetary Fund defines Foreign Exchange Reserves as the External Assets held by the Central Bank or other Monetary authority of a nation, primarily available to finance the Balance of Payment requirements of the country, in order to influence the Foreign Exchange Rate of its currency and to maintain confidence in the domestic markets.[iii]

The Foreign Exchange Reserves are vital to a nation’s economic health. In the absence of adequate reserves, an economy can come to a halt and may be unable to pay for their critical imports, for example Crude oil. Further, during periods of crisis, for example flood or volcanic eruption, when the supply of foreign currency is severed, the local importers exchange their domestic currency with the Central Bank which allows them to pay for the imports. Hence, through these Forex Reserves, the Central Bank maintains liquidity during such cash-strapped periods.[iv] Thus, the ultimate purpose that the reserves fulfill is that they provide a back-up of funds, if under certain circumstances, the value of the domestic currency rapidly de-values or all together becomes insolvent, enabling an economy to effectively cushion a market shock.

Let us take the example of Saudi Arabia to understand the importance of Forex Reserves. Saudi Arabia is a country whose 40% of overall GDP is directly dependent on the export of their vast oil reserves.[v] If the oil prices begin to fall drastically, there is a probability that their economy will suffer. Hence, the economy of Saudi Arabia possesses huge amounts of Forex Reserves which will act as a cushion (especially during the short-run), if such circumstances occur.

In the context of India, the Foreign Exchange Reserves include the following:

  • Foreign Currency Assets (FCAs)
  • Gold
  • Special Drawing Rights (SDRs)
  • RBI’s Reserve position with International Monetary Fund (IMF)

Amongst the four, the FCAs usually constitute the largest component of the Forex Reserves. Economists suggest that it is better to hold the Forex Reserves in a currency which is not one’s domestic currency in order to provide a barrier, in case there is a market shock.

Owing to the fact that USD is the de-facto global currency since it is the most traded in international transactions; the majority of the nations hold their considerable portion of FCAs in USD.[vi] One of the reasons why the USD is viewed as a global currency is because the United States is home to well-developed financial markets and robust legal and political institutions.[vii] As a result, the USD is a relatively stable currency. This means that the transacting parties don’t need to fret over the value of their payments fluctuating wildly.[viii]

The recent report of the IMF on the “Currency Composition of Foreign Exchange Reserves”,[ix] observed that USD is perhaps the strongest reserve currency since 62.7% of the world’s currency reserves are kept in the said currency. Thus, the majority of the nations prefer to hold their FCAs in USD. However, other currencies including the Euro, Yuan and the Yen, amongst others, also makes up certain proportions of the Global Reserves.

Similarly, during the week that ended on April 9, 2021, the FCAs, a major component of the overall reserves, increased by USD 3.02 billion, consequently raising the total to USD 539.45 billion.[x] Possibly, the export industry of India along with the valuation of the Rupee might strengthen against the USD.

The total value of the gold reserves continued to rise by USD 1.30 billion to USD 35.32 billion. The SDRs held by the IMF rose by USD 6 million bringing the total to USD 1.49 billion, while India’s reserve position with the IMF rose by USD 24 million leading to a total of USD 4.95 billion during the reporting week.[xi]

REASONS FOR THE INCREASE:

INCREASE IN FOREIGN DIRECT INVESTMENT

According to the United Nations Conference on Trade and Development (UNCTAD), India was amongst the top 10 recipients of Foreign Direct Investment (FDI) in 2019, attracting USD 49 billion inflows and witnessing a 16% increase from the previous year.[xii] Thus, FDI has been a major source of non-debt finance for the economic development of India. To facilitate the same, the Government of India has adopted an investor friendly policy on FDI which manifests a progressive liberalization across various sectors.

However, it is believed that India has far more potential which can be achieved only through further liberalization and simplification of the FDI norms. Accordingly, the Government has undertaken several amendments in the current regime of the FDI, highlighted below:

COAL MINING

Subject to the provisions of Coal Mines (Special Provisions) Act, 2015 and the Mines and Minerals (Development and Regulation) Act, 1957, the Government has permitted 100% FDI under automatic route for sale of coal and coal mining activities including associated processing infrastructure. Such infrastructure would include coal washery, crushing, coal handling, and separation (magnetic and non-magnetic).[xiii]

Thus, the long established monopoly of the Coal India Limited is now stripped-off. It is expected that such liberalization would attract multiple players and would create a competitive market leading to price stablisation in the long run.

Further, even though India possesses the 4th largest coal reserve in the world, it imported 235 million tonnes of coal in 2019, out of which, 135 million tonnes could have been substituted through domestic reserves.[xiv] Hence, with increased production through this policy initiative, India could achieve its long awaited goal of import substitution and tackle the widening trade deficit.

CONTRACT MANUFACTURING

In order to boost the manufacturing sector, the Government of India has decided to allow 100% FDI under automatic route in contract manufacturing in India. Manufacturing activities may be conducted either by the investee entity or through contract manufacturing in India under a legally tenable contract, whether on Principal to Principal or Principal to Agent basis.[xv]

Such activities, similar to manufacturing outsorce, are expected to provide the much-needed impetus to ‘Make in India’ by boosting the manufacturing sector, through establishment of new facilities and improving utilisation of the existing ones. Such relaxation aims at enabling a multiplier effect characterized by higher domestic employment opportunity, rise in the income of the workers and a surge in exports, boosting the economy as a result.

SINGLE-BRAND RETAIL TRADING (SBRT)

The existant FDI Policy provides that 30% of the value of goods has to be procured from India, if the SBRT entity has FDI more than 51%. However, according to the relaxed norms, local sourcing requirements can be met as an average during the first 5 years, and thereafter, annually towards its Indian operations.[xvi] The move is expected to provide greater flexibility and ease of operations for the firms.

Further, the amended FDI norms have liberalized the local sourcing requirements, restrictions  imposed on exports and rules regarding raising of funds for global operations. The move is expected to create positive market sentiments for the SBRT and its viability in India.

Brick and Mortar Store Requirement:

Earlier, the FDI Policy required that an SBRT entity is to set up a physical brick and mortar store before it could undertake any retail trading of its brand through e-commerce. This restriction was not in line with with current market practices, hence, through the amendment of  Para 5.2.15.3 in the erstwhile FDI Policy of India,[xvii] an SBRT entity is permitted to undertake retail trading of its brand through e-commerce prior to the opening of brick and mortar stores, subject to the condition that the entity opens brick and mortar stores within 2 years from the date of commencement of any online retail operations. Online sales will yield positive dividends through the creation of jobs in logistics, digital payments, customer care, training and product skilling.[xviii]

COMMENT:

The above-mentioned liberalization and simplification of the FDI norms is truly forging ‘Ease of Doing Buisness’ in India. It can be evidenced through the rising investments and the recent surge in FOREX Reserve of India. As the FCAs rise through the higher inflow of USD, the value of Indian currency weakens, thus, facilitating higher and cheaper exports against the American goods, boosting sales and economic prosperity. Thus, the move seems to be a positive step towards reviving the economy and increasing customer confidence. However, its real impact could be analysed in due course of time.

DECLINE IN IMPORT BILL

India is the world’s third largest crude oil consumer.[xix] However, unfortunately, it is devoid of any large reserves of such natural resourse. As a result of which, it imports around 85% of the total oil that it consumes.[xx]

Amidst the pandemic, several countries have resorted to lockdowns to ‘flatten the curve’ of the infection.[xxi] These lockdowns meant confining millions of people to their homes, shutting down businesses, halt in the production lines and ceasing almost all economic activity. During such periods of economic slowdown characterized by a drastic fall in the sales and profits. During such period, the demand associated with crude oil also drastically plummeted. In light of the same, the price of the crude-oil has come to a historic 20 year-low,[xxii] be it the BRENT crude (Brent refers to oil that is produced in the Brent oil fields and other sites located in the North Sea)[xxiii] or WTI (West Texas Intermediate is the preferred pricing model in United States),[xxiv] the prices are at a staggering low.

Further, as nations are busy battling Covid-19, Saudi Arabia launched an all-out oil war, with the biggest cut in its prices in the last 20 years after a failure by OPEC+ to clinch a deal to cut production, owing to Russia’s opposition. As a result, the oil prices crashed in global markets. [xxv] However, the unprecedented phenomenon could, indeed, be a blessing in disguise for India.

During 2019-2020, India’s crude import bill amounted to USD 102 billion.[xxvi] Owing to the Covid-19 Pandemic and the falling oil prices, the Petroleum Planning and Analysis Cell (PPAC) under the Ministry of Petroleum and Natural Gas, Government of India has predicted that India’s crude import bill might fall by 60%, if the prices remain at USD 64 per barrel.[xxvii] However, in contrast, the prices have fallen far below the said amount. As a result, there is a probability that India could save its precious Forex Reserve. In light of the same, the analysts have recently released new predictions, concerning India’s import bill, which are as follows:

  • If the prices remain at USD 50 per barrel range for the rest of the year, India may save around USD 22 Billion in its import bill;
  • If the prices stay below USD 35 per barrel for the rest of the year, India’s savings could be a whooping USD 30 billion.[xxviii]

Thus, the widening Current Account Deficit of India could be restricted in the coming times, if the prices remain under the afore-said range. Efficient Forex Reserve can be achieved only when the balance of trade is optimized. India, in light of the same, has started filling up their Strategic Petroleum Reserve (SPR). SPR refers to the crude oil inventories (or stockpiles) held by the government of a particular country, as well as private industry, to safeguard the economy and help maintain national security during an energy crisis.[xxix] In India, the SPR is maintainted by the Indian Strategic Petroleum Reserves Limited (ISPRL), a wholly-owned subsidiary of the Oil Industry Development Board (OIDB), functioning under the administrative control of the Ministry of Petroleum and Natural Gas, Government of India.[xxx] However, its restricted capacity of 39 million barrels,[xxxi] is one amongst other such barriers.

CONCLUSION

The rising Forex Reserve of India owes its origin to the higher inflow of USD. The same is achieved through the liberalization and simplification in the FDI norms. Additionally, the falling oil prices have also brought considerable relief to the the import bill of the country. All such methods are not only bolstering the Forex Reserve of India but are also strengthening the value of the Rupee. Thus, India is in line to achieve its effective goal of having the value of its currency in competitive terms with USD but definitely not greater than it. This is because if the value of India’s currency would remain less but competitive with USD, the exports from India would become relatively cheaper against the American goods, hence, inducing sales and economic prosperity. The Manufacturing Sector of India particularly with respect to the Coal Mining Operations, Single Brand Retail and Contract Manufacturing also received its due share of Policy Framework, potentially generating formal and productive jobs, inducing exports and revenue growth in the long-run. Therefore, we can conclusively state herein, that the Policy is in conformity to achieve the long awaited goal of an ‘Atmanirbhar Bharat’[xxxii] characterising Import Substitution, Narrow Current Account Deficit and a favourable Balance of Payement Ratio concerning the Domestic Producers and Consumers.


[i] M. Minhaz, “India’s Post-Pandemic Pathway To A $5 Trillion Economy”, Swarajya Mag, https://swarajyamag.com/economy/indias-post-pandemic-pathway-to-a-5-trillion-economy (20.04.2021)

[ii] Weekly Statistical Supplement, Reserve Bank of India, https://m.rbi.org.in/Scripts/WSSViewDetail.aspx?TYPE=Section&PARAM1=2 (15.04.2021)

[iii] https://www.imf.org/external/np/mae/ferm/eng/index.htm (14.04.2021)

[iv]Debt- and Reserve-Related Indicators of External Vulnerability”, IMF, https://www.imf.org/external/np/pdr/debtres/ (12.04.2021)

[v] Naser AL-Tamimi, “Saudi Arabia’s Oil Dependence: Challenges Ahead”, ISPI (Istituto per gli studi di politicainternazionale), https://www.ispionline.it/it/pubblicazione/saudiarabiasoildependencechallengesahead14997#:~:text=Oil%20is%20the%20main%20pillar,over%2040%25%20of%20overall%20GDP. (05.03.2021)

[vi] Kimberley Armadeo, “Why the US Dollar Is the Global Currency”, The Balance, https://www.thebalance.com/world-currency-3305931 (13.04.2021)

[vii] Kimberly Amadeo, Michael J. Boyle, “Why the US Dollar Is the Global Currency”, The Balance, https://www.thebalance.com/world-currency-3305931 (05.03.2021)

[viii]Foreign Exchange Reserves”, CFI, corporatefinanceinstitute.com/resources/knowledge/finance/foreign-exchange-reserves/ (08.03.2021)

[ix] https://data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4 (05.03.2021)

[x]Forex reserves surge by $4.34 billion to $581.21 billion: RBI data”, Buisness Standard,  https://www.business-standard.com/article/economy-policy/forex-reserves-surge-by-4-34-billion-to-581-21-billion-rbi-data-121041601005_1.html (15.04.2021)

[xi]India’s forex reserves surge to all-time high of $493.48 billion”, Live Mint, https://www.livemint.com/market/commodities/india-s-forex-reserves-surge-to-all-time-high-of-493-48-billion-11591382575512.html (03.03.2021)

[xii]India Among Top 10 Fdi Recipients: Un Report”, The Hindu Business Line, https://www.thehindubusinessline.com/economy/india-among-top-10-fdi-recipients-attracts-49-billion-inflows-in-2019-un-report/article30308178.ece (03.03.2021)

[xiii] Foreign Direct Investment in Commercial Coal Mining in India, PIB, https://pib.gov.in/PressReleaseIframePage.aspx?PRID=1643176 (10.04.2021)

[xiv]Coal rules eased to spur investment”, Hindustan Times, https://www.hindustantimes.com/india-news/coal-rules-eased-to-spur-investment/story-btRTXgXImglLyVJxzmBTqI.html (12.04.2021)

[xv]DPIIT notifies FDI relaxation norms in coal mining, contract manufacturing, single-brand retail”, Economic Times (ET), https://economictimes.indiatimes.com/news/economy/policy/dpiit-notifies-fdi-relaxation-norms-in-coal-mining-contract-manufacturing-single-brand-retail/articleshow/71186595.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

[xvi]Cabinet approves proposal for Review of FDI policy on various sectors”, PIB, https://pib.gov.in/PressReleasePage.aspx?PRID=1583294#:~:text=to%20Agent%20basis.-,Single%20Brand%20Retail%20Trading%20(SBRT),has%20FDI%20more%20than%2051%25 (10.04.2021)

[xvii] Review of Foreign Direct Investment (FDI) policy on various sectors, Ministry of Commerce & Industry, https://dipp.gov.in/sites/default/files/pn4_2019.pdf (20.04.2021)

[xviii] Ravi Shah, Ravisha Seth, Single Brand Retail Trading: “A tale to harmonise NDI Rules with the FDI Policy”, https://corporate.cyrilamarchandblogs.com/2020/05/single-brand-retail-trading-a-tale-to-harmonise-ndi-rules-withthefdipolicy/#:~:text=FDI%20in%20SBRT%20is%20subject,must%20be%20branded%20during%20manufacturing (13.04.2021)

[xix]India becomes third largest oil consumer”, The Hindu, https://www.thehindu.com/business/Industry/India-becomes-third-largest-oil-consumer/article14391860.ece (20.04.2021)

[xx] Saket Sundria, Debjit Chakraborty, “Oil demand slumps 70% in India as third-biggest buyer shuts down”, ET, https://economictimes.indiatimes.com/industry/energy/oil-gas/oil-demand-slumps-70-in-india-as-third-biggestbuyershutsdown/articleshow/75058788.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst (05.03.2021)

[xxi]Lockdown may help flatten COVID-19 curve”, Deccan Herald,  https://www.deccanherald.com/national/lockdown-may-help-flatten-covid-19-curve-in-india-says-study-820401.html (19.04.2021)

[xxii] Pippa Stevens, “‘Scary,’ ‘visceral,’ ‘unprecedented’: Traders describe oil’s wild week and fall to negative prices”, CNBC, https://www.cnbc.com/2021/04/25/scary-visceral-unprecedented-traders-describe-oils-wild-week-and-fall-to-negative-prices.html (05.03.2021)

[xxiii]What is Brent crude?”, The Economics (19.04.2021)

[xxiv] CME Group, https://www.cmegroup.com/trading/why-futures/welcome-to-nymex-wti-light-sweet-crude-oil-futures.html (20.04.2021)

[xxv]How crude oil price crash might help India offset Covid-19 economic loss”, The Week, https://www.theweek.in/news/biz-tech/2021/03/10/how-crude-oil-price-crash-might-help-india-offset-economic-loss-due-to-covid-19.html (03.03.2021)

[xxvi] Sanjeev Chaudhary, “India’s crude oil import bill fell 9% to $102 billion in 2019-20”, ET,
https://economictimes.indiatimes.com/news/economy/foreign-trade/indias-crude-oil-import-bill-fell-9-to-102-billionin201920/articleshow/75473757.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst (21.04.2021)

[xxvii]Covid-depressed oil market to save India billions in import bill”, Economic Times, https://energy.economictimes.indiatimes.com/news/oil-and-gas/covid-depressed-oil-market-to-save-india-billions-in-import-bill/74467544 (05.03.2021)

[xxviii]Oil trade comes to a halt, but India’s import bill gets cheaper”, New Indian Express, https://www.newindianexpress.com/business/2021/may/03/oil-trade-comes-to-a-halt-but-indias-import-bill-gets-cheaper-2138400.html (03.03.2021)

[xxix]Strategic Petroleum Reserve”, US Department of Energy, https://www.energy.gov/fe/services/petroleum-reserves/strategic-petroleum-reserve/strategic-petroleum-reserve-0 (18.04.2021)

[xxx] Indian Strategic Petroleum Reserves Limited, http://www.isprlindia.com/aboutus.asp (20.04.2021)

[xxxi] Kalpana Pathak, “India misses a trick due to lack of oil storage capacity”, Live Mint,

https://www.livemint.com/industry/energy/india-misses-a-trick-due-to-lack-of-oil-storage-capacity-11587489898431.html (07.03.2021)

[xxxii] https://www.makeinindia.com/atmanirbhar-bharat-abhiyaan (15.04.2021)

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