4 Reasons India’s Growing Currency Can Be a Problem | India News
At the very least, we need foreign exchange to pay for crude oil imports, transportation and logistics support. We also depend on imports for a variety of items, including vaccine supplies, steel, and auto components. Are there any downsides to having a large war chest of dollars? It’s complicated, but yes, it has its downsides. First, some good news.
Solid economy sign
Unlike the major central banks that hoard the dollar (China, Russia, Saudi Arabia and Japan), we are not an export surplus country. Much of your stack is accumulating from years of earning more dollars than you spend. For us it is the opposite. We may be the only major Asian country with a current account deficit, that is, we import much more than we export, and we still have large foreign reserves. That is commendable.
If every year we fall short in dollars, how is it that our forex stocks keep rising? The reason is that the current account deficit is offset by a large influx of capital flows. Dollars enter India through foreign portfolio investors (FPI) or as foreign direct investment (FDI). This entry of the purchase of assets such as shares shows the confidence of foreign investors in the growth prospects of India.
In the past three decades, India has attracted nearly $ 500 billion in FDI. Beyond the inflows of FPI and FDI in the stock market, there are loans. These are called external business loans. Total foreign loans outstanding is $ 560 billion, or about 93% of our foreign exchange reserves. That is inconvenient.
Stock market entries, especially FPI, can easily and abruptly turn around. Such investors can be fickle, nervous, or just plain risky, and will raise funds in the blink of an eye, although getting FDI is not that easy. Similarly, Indian companies that have large short-term and long-term loan dollar obligations are also a warning sign. We need enough dollars to pay off short-term debts at least.
Even NRIs can withdraw large dollar deposits suddenly. That’s what they did in 1990 when there was panic before the first Iraq war. Also, if India’s rating falls below investment grade, no foreign lender would be willing to refinance our previous loans. Our coffers are going to be empty to repay loans. That is why large Indian currency stocks, insofar as they have fickle flows, should not make us complacent. Unless our exports exceed imports, we will remain vulnerable.
Idle money shakes the rupee
The second disadvantage of a large amount of dollars is that it generates very little interest. If it represents a national good, is there a better use for it? Third, large foreign holdings in the Indian stock market make its value vulnerable to currency ebbs and flows. In fact, the rupee generally strengthens on days when the stock market rises, and vice versa. Is it healthy that the purchasing power of our importers depends on fickle foreign investors?
Addiction to ‘free money’
The fourth downside is that a large currency stack means that RBI’s balance sheet swells. Since the balance sheet is measured in rupees, it expands every time the rupee weakens. This is a “free” profit for RBI, which can then be passed on as dividends to the Center. A very large balance sheet size means that even a slight weakening translates into “notional” gains of billions of rupees, or gains for RBI.
When the currency fluctuates, gains and losses should not normally be collected. But the large appreciation gains from the rupee’s weakening could become a continuing source of fiscal finance for a central government in desperate need of it. This can lead to a tax “addiction” or even a dilution of RBI’s independence.
Look beyond the US dollar
The dollar is not our currency. Too much can become a headache. Unlike rupee debt, we cannot forgive our dollar debt. Countries like Russia, despite having large foreign reserves, are moving away from the dollar. There are geopolitical tensions with the US and Russia does not want to depend on New York clearing banks (dollar transactions can only be cleared by US banks). India should also seek to diversify its holdings of currencies away from the dollar and examine the optimal size of foreign reserves for our needs.