It should give our Cyclops-like political parties, fixated on the deferred disinvestment, a stick to wield against the government. But India's forex reserves, the seventh largest in the world at $67 billion-and-growing, inspires only fool's awe. On the positive side, we have a cute current account surplus, our banks are flush with funds, and the rupee has actually hardened against the dollar a wee bit. Sure it makes one feel good that foreigners are looking at India with renewed respect. And that we have more forex than Malaysia, Indonesia or Thailand and are better equipped to deal with any cataclysmic event triggering panic outflow of funds.
But we may be paying a huge price to accumulate these reserves. Since the RBI doesn't want the rupee to appreciate and make exports dearer, it buys dollars and releases rupees. Despite continuous "sterilisation" in the past two years, the rupee has appreciated about 2 per cent from its record low in May. Result: more money is drifting into the region, considering the depressed outlook in the rich countries vis-a-vis the comparatively prosperous prospects for the Asian region. Most of this actually comes from expat Indians, but at a very high cost. Almost half of our forex reserves are money payable to NRIs!
Says Arvind Panagariya, professor, University of Maryland: "The extra benefit from further expansion of reserves is virtually zero. But we pay a much higher interest on our total external debt. So it makes no sense to collect forex beyond what's necessary to ensure confidence in the RBI's ability to defend the rupee." So why and how did our forex pile up to outstrip money supply? One, because we can't help the inflows and two, because we are encouraging it. The growth in reserves in the past two years has been mainly on account of a strong flow of FDI and NRI deposits. In 2001-02, out of $9.5 billion of capital inflows, FDI came close to $4 billion and NRI deposits $2.1 billion. (Portfolio or fii investment, $2 billion last year, has dried up to a few millions.)
While FDI flows were down 7 per cent in the first six months of 2002-03, NRI deposits were up by $1.42 billion between April-August this year. With this, the total outstanding NRI deposits came to $26.6 billion (including $10 billion of 1998 Resurgent India Bonds or ribs, and 2000 India Millennium Deposits or imds). The inflows will only increase due to the much improved investment climate. Thanks to India's changing balance of payments structure with trade deficit narrowing due to depressed imports and rising invisible earnings ($12.5 billion in '01-02) due to higher services exports.
But only in India can we turn a happy situation into a disadvantage. Instead of profiting from this, we are actually ending up sending our resources out. How? For one, says a finance ministry official, our precious forex reserves are invested mostly in short-term government securities in OECD countries (half of them are in the US), where the yields are 0.5-1 per cent in real terms. Reveals icrier professor Ila Patnaik, "The country pays an average of nine per cent in real terms on our capital flows. In essence, we are losing, say, about $1.6 billion a year on the new reserves of $20 billion that were added in 2002." Should we allow such poor management of our national funds?
Secondly, why are we allowing such high-cost NRI deposits? Rupee deposits (nre) are paying so well that most NRIs are borrowing locally to put in Indian bank branches. Right now, some like Global Trust Bank, IndusInd Bank and Bank of Punjab are paying upwards of 7.5 per cent for even 6-month deposits. A series of relaxations this year made the rupee completely convertible for NRIs, and deposits more attractive. As a result, there has been a 25 per cent jump in deposits from Gulf NRIs alone.Secondary market premia for IMDs, maturing in 2005, are ruling at 12 per cent, as against its coupon rate of 8.68 per cent annually.
Admits a senior RBI official: "The differential is basically between the domestic rate (say, 91-day treasury bill rate) and the overseas rate (US T-Bills rate) plus the rate of depreciation." In simple terms, checking account deposits in the US yield a little over one per cent while deposits above $10,000 and $30,000 pay 1.5 and 1.75 per cent respectively. The interest differential is thus over 600 basis points, says a treasury economist with an FII. Adds Alok Vajpeyi, president, dsp Merrill Lynch Investment Managers: "An average of 7-8 per cent is a good return from a global currency perspective. Add to this the likelihood of rupee appreciation against the dollar in the near future."
Many economists are openly calling the NRI schemes a complete scam—in fact, the IMDs had run into trouble with the US Fed. Former chief economic advisor Ashok V. Desai suggests they all be closed down or their interest rates aligned with international ones. As he puts it: "The RBI should prohibit the taking of all fresh NRI deposits and allow repayment of existing ones when they mature. That will reduce reserves by a third at least." Former RBI deputy governor S.S. Tarapore too agrees that "they should be gently wound down and there should be one single scheme where the depositor bears the exchange risk". Adds a senior foreign ministry official: "Presumably, there are strong lobbies for the NRI schemes." That could be true since the bjp and its wings have strong linkages with the NRI community across the world.
Says a central bank economist: "RIBS and IMDS were PR exercises. But, of late, the inflow is accounted for partly by the push factor. That means investors are diversifying from elsewhere—possibly a current account restructuring in the US or weakening dollar—to a country that poses no risk in terms of fundamentals and has good stocks to offer." The stability of the rupee also helps the banks, says Tarapore. Adds Panagariya: "With market-determined rates, the banks raise the funds and then lend them in the domestic market at a higher rate and still come out ahead since the rupee is not depreciating fast enough. That brings us to the problem of high domestic interest rates."
A rising rupee is clearly not good for our exports. In fact, the RBI's latest move to have resident forex accounts is expected to further encourage forex flows, even hawala funds in part. Meanwhile, as Tarapore says, "Unusual situations need unusual remedies. We have to use a incentive/disincentive system." Like liberalising the credit markets, minimising interest rate differentials, raising cash-reserve ratios for NRI deposits, paying off old high-cost ibrd or ADB loans, etc.
The best remedy to such an impasse is full convertibility of the rupee. Says Vajpeyi: "As economic growth gathers force and the window of convertibility widens, there'll be pressure on outflows. A robust forex balance gives the RBI more leeway to manage the convertibility window." However, the RBI isn't too keen to pursue full convertibility as our financial sector is not mature enough, and the central bank is still worried about sudden outflows due to domestic instability. So, abandoning the distinction between residents and non-resident Indians is unlikely to come about soon. It can happen only when the current account becomes sustainable in the medium term. That happens only when exports move faster.
So, Panagariya and many others suggest, why don't we go full-steam ahead with our trade liberalisation? By improving imports and value-added exports, we will use more forex and relieve the upward pressure on the rupee. Any takers on Mint Street?