The far reaching reforms being ushered in by the Modi government is giving confidence to foreign investors to pour in billions of dollars of foreign exchange into India.
Amid the gloom of India’s projected GDP contraction of 7.5-8.0 per cent, comes some very good news. The country is now a net creditor globally. This means it has more foreign exchange reserves than foreign debts.
As of February 6, India’s foreign exchange reserves stood at $590 billion, an all-time high. Its foreign debt, on the other hand, was $554 billion. The credit side is, thus, heavier by $36 billion over the debit side.
This is good news and reflects well on the management of the Indian economy and its macro-environment by the Modi government and the Reserve Bank of India (RBI).
A legitimate question arises: Why are foreign exchange reserves rising at a time when the economy, though recovering from its deepest ever slump in the first quarter of the current fiscal, is still facing stress?
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There are two reasons for this – one intrinsic to the Indian economy and one largely extraneous to it, but both are inexorably linked to each other.
The intrinsic reason is that the post-Covid global order is changing. And, as Indian Prime Minister Narendra Modi has pointed out, India will play an increasingly larger and more decisive role in shaping the contours of the new world economic and geopolitical order.
And, as the only billion-plus population market that is open for business, it is a natural magnet for global investors, who have the foresight to look beyond the immediate numbers to a future where the Indian market will be one of the world’s most lucrative and competitive, especially in the light of the far reaching reforms being ushered in by the Modi government.
That is why, record amounts of foreign direct investments (FDI) and foreign portfolio investments (FPI) are pouring into the country. FDI inflows during 2020 calendar year rose 13 per cent to $57 billion, according to a report by UNCTAD.
Net inflows from FPIs in calendar year 2021 (up to February 8) is $3.904 billion, data on the NSDL website shows. This includes net inflows of $4.331 billion into equities and net outflows of $426 million in debt and hybrid instruments.A part of these inflows are a result of the US and several western countries opening the floodgates of cheap money to shore up their Covid-hit economies. A significant portion of this global liquidity is finding its way into emerging markets, including India.
The rising forex kitty will provide comfort to the government, the RBI as well as foreign and domestic investors that the Indian economy is well placed to absorb any internal or external shock at a time of great global uncertainty as these funds can cover the country’s import bill for a year.
India’s overflowing foreign exchange kitty is also leading to a strengthening of the rupee against the dollar. Though this will make imports more expensive, it will also give confidence to investors that the country can meet all its external obligations as its domestic currency is backed by external assets like US T-bills, bonds of other central banks, gold reserves and Special Drawing Rights (SDR) of the International Monetary Fund (IMF).
The Modi government and the RBI, thus, deserve kudos for their management of the Indian economy in very uncertain times for the world economy.
If there’s one area that could, perhaps, do with a review, it is the fact that this huge sum of money earns very little by way of returns – of less than 1 per cent per annum.
There is a school of thought that advocates spending a part of these reserves for building infrastructure in the country. The RBI has, in the past, dismissed this option out of hand.
At a time when the Modi government is redoubling its efforts to build world class infrastructure in India, there may be some merit in taking another look at this proposal.