Over the last few months, the rapid growth in India’s forex reserves has resulted in India’s ranking moving up from 10th to 5th. Over the last one year even as the FPI flows have been volatile, the FDI flows continue to be robust and the foreign remittances into India have been at elevated levels. Also, the RBI has not been too active in intervening to protect the rupee value and that has also ensured that the forex reserves are conserved. All these factors jointly led to the forex reserves touching $508 billion levels in Jun 2020.
A long way since the crisis of 1991
One of the low points of the Indian economy was in 1991 when the Indian government was left with forex reserves to cover just 20 days of imports. That almost put India in line for a major downgrade. However, this was resolved with an emergency line of credit from the IMF for which India had to pledge gold with the Bank of England. In a way, this crisis forced India to embark on the economic reforms program of 1991 and the rest, as they say, is history. From having reserves to cover just 20 days of imports, India has come a long way to hold the fifth largest forex chest, sufficient to cover 14 months of normalized imports.
Even as late as 2001, the forex reserves were just about $43 billion and the real growth came after that as can be seen from graphic below.
Between 2013, when India saw a major run on the currency post the Fed announced tapering, and 2020 the forex chest literally doubled to the current levels. That brings us to the billion dollar question; what can India do with this surfeit of forex reserves?
Option 1: Now sovereign bonds look more feasible
In the Union Budget 2019, the government announced its intent to raise $10 billion via the issue of sovereign bonds. Currently, India does not adopt the sovereign bonds route as it has the potential to impact the external ratings of the Indian economy. The announcement in 2019 came as a whiff of fresh air as it would have allowed the RBI to reduce its dependence on domestic bond markets.
However, the sovereign bond proposal was not approval after the PMO had raised serious apprehensions about its likely impact on the sovereign ratings. The PMO had also expressed concerns over the possible impact of sovereign bonds on the currency volatility, especially if the rupee showed signs of weakness. These were some of the reasons why the idea of sovereign bonds was shelved despite being announced in the Union Budget.
However, with a forex chest of $508 billion and no sovereign bonds to worry about right now, the government could find itself in a much more comfortable situation. The forex chest largely consists of inward remittances and FDI flows, both of which are fairly stable. The government can use this opportunity to tap sovereign bonds to reduce domestic yield pressure, in a year when fiscal deficit is expected to shoot up.
Option 2: Time to look at a Sovereign Wealth Fund (SWF)
This has been discussed in the past but was never really implemented. The idea of a sovereign fund is to allocate the forex chest into a SWF that would make more of market related investments in the quest for higher risk-adjusted returns. Take the case of the heft enjoyed by some of the largest sovereign funds in the world like Norwegian Pension fund or the Abu Dhabi Investment Authority or the Japan Pension Fund or even Temasek of Singapore. All these sovereign funds have steadily built up wealth for their nations by investment in higher yield investments like equities and real estate.
India still relies predominantly on the treasury securities issued by the US and European central banks. Such investments hardly give any yield although they are safe. But at a time, when the government can do wonders with a slightly higher yield, a sovereign wealth fund does make a lot of sense.
Today, RBI and the government have a problem of plenty. Forex reserves cover more than 14 months of imports and that is at par with other BRICS benchmarks. It is time to put the forex chest to more productive use. SWF could be an answer!