Volume 5, No. 4, April 2004

One of the three major planks in the ‘India Shining’ campaign is the bulging forex reserves. The foreign exchange ‘constraint’ which plagued the economy during the first four decades of economic planning has given way to continuous increase in inflow of foreign currency resources since 1991, so much so that India can now boast of having the sixth largest dollar reserve in the world. This change occurring as it did against the backdrop of globalisation is projected as the remarkable success of ‘economic reforms’ which is an euphemism for the ‘free’ market mantra which passes as the ‘‘Washington consensus’’ (a consensus between the IMF, world Bank and the US Treasury which is the IMF’s largest shareholder, about the ‘‘right’’ policies for the underdeveloped countries.)

It is interesting to note that India’s forex reserves increased in the period 1990-2003. The journey from ‘agony to comfort’ still continues. It is evident from the following table:

The country is now no longer required to lead a hand-to-mouth existence, frantically finding out ways to pay for imports or to repay short term debt. The import cover (defined as the twelve times the ratio of reserves to merchandise imports) which shrank to 3 weeks of imports by the end of December 1990 improved to about 11.5 months as at end-march 2002, and further to 19 months as at present. Side by side, the sustainable external debt position is vindicated by the fact that short term debt component has decreased from 10 percent as at end-march 1991 to 3 percent as at end-March 2001. Similarly, the size of debt service payments relative to current receipts has decreased from 35 percent in 1991 to 16 percent in 2001, indicating thereby that the country was able to wriggle itself out of the debt trap, though the volume of external debt remained more or less unchanged when forex reserves went on rising.

What is significant to note is that much of the increase in forex reserve occurred during the past two years. In 2002-03 the reserve increased by US $ 22 billion and in the nine months of 2003-04 it increased by US $ 28 billion. That is why, the multilateral bodies (IMF-World Bank-WTO) and the US have been pressurising for more capital market liberalisation in India, relying on the simplistic reasoning: Free markets and economic efficiency are conterminous, faster growth requires greater efficiency. If with acceleration of capital flows, and integration of financial markets domestically and globally develop, India could build up a war chest of foreign currency, the argument runs, she should now take the plunge and make the rupee fully convertible on the both the current and capital accounts of the balance of payments and simultaneously liberalise the capital market in toto in order to attract foreign capital, especially foreign direct investment (FDI). This logic is flawed on several counts. First, in order to attract FDI, capital market liberalisation is not necessary. China became the destination of a huge sum of FDI without capital market liberalisation. Secondly, given the high savings rate our country hardly needs additional funds. We face the difficult task of channeling the flow of savings in desired lines of investment. Otherwise savings will pile up in banks, continuously pushing the rate of interest further down. Thirdly, FDI itself is a vehicle of economic drain: foreign companies often overrun local ones. Such investment often flourishes only because of special privileges extracted from the government (often those privileges are the results of corruption, the bribery of top-notch bureaucrats and ministers). The inflow of capital leads to an appreciation of the country’s currency, making imports cheap and exports dearer. Fourthly, removal of exchange and capital controls makes room for the influx of hot money into and out of the country. Rapid capital market liberalisation was not attempted by today’s developed world earlier until the nineteen seventies. Asking the developing countries with their not so mature banking system amounts to, what joseph stiglitz points out, ‘‘setting them off on a voyage on a rough sea, before the holes in their hulls have been repaired, before the captain has received training, before life-vests have been put on board.’’ Even in the best of circumstances there is every likelihood that ‘‘they would be overturned when they were hit broadside by a big wave’’ [Globalisation and Its Discontents, Penguin (2002), page 17]. The risk is that when our country faces difficulties the foreign lenders or investors will pull their money out at the first sign of trouble – exacerbating the economic downturn as indicated by the East Asia crisis in 1997. Finally, our vision should not be allowed to be blurred only by the potential benefits of liberalisation like our amassing massive dollar reserves which provide ability to pay for imports and service the external debt.

We should be cautious about the risks involved and the costs inherent in such huge forex reserves. The risk is in attracting potentially volatile capilal. Already such volatile capital has entered the country in the form of NRI bank deposits, foreign institutional investors’ (FII) funds in the stock market, outstanding commercial borrowings, suppliers’ credit and all short term loans. Aggregated together they come to almost two-thirds of the total forex reserves. The FII funds were negligible in 2002, but they exploded in the second half of the year 2003. The rise in secondary market prices of shares was caused mostly by steep fall in interest rates on bank deposits. The FII portfolio investment which crossed $ 10 billion in 2003 was clearly aimed at reaping huge gain out of rising prices of shares in secondary markets. But while doing so, it causes an appreciation of the Re. The NRI deposits in Indian accounts are also aimed at taking advantage of the appreciation of the rupee.

Another major factor, in fact the single largest factor driving the accretion in foreign exchange reserves in the year 2002-03 was banking capital. Banks borrowed aboard at low interest rates and lent at home at higher interest rates. [Very low interest rates in advanced capitalist countries is accounted for by serve recession]. Is it then a fact that with US $ 106.6 billion forex reserve, India is able to hold the fort comfortably? Perhaps it will be too early to make such forecast. Let us not forget the caution voiced by Dr. Bimal Jalan in one of his last speeches as the Governor of the RBI. He pointed out that with full convertibility, the residents may, if they so desire to, transfer their deposits abroad. In that event, $ 290 billion equivalent of India’s bank deposits – roughly three times the foreign exchange reserves – may leave the country in search of greener pastures, precipitating a crisis far bigger in dimension than that in Argentina in 2001. Even if a fraction of these deposits are stashed away or simply transferred to a foreign territory, it will, without difficulty, be enough to destabilise the balance of payments.

One more danger lurking beneath the calm appearance of the bulging forex reserves is the potential threat to the balance of payments stability posed by the appreciation of the rupee caused by massive inflow of foreign funds. Despite much of the efforts of the RBI, the inflow could not be checked in recent years. The appreciation of the rupee has made its impact felt on the current account. Exports have become non-competitive and imports have started growing. Invisible receipts are likely to fall if BPO (business process outsourcing) is checked by the governments of the crisis-redden imperialist countries. All these will inevitably lead to a current account deficit. Rupee value will then depreciate. Inflows of capital may then dry out and in fact, a reversal of capital inflows may take place. This is not likely to happen right now. But if this process continues then with full capital account convertibility (ie. With removal of all controls on even capital outflows. The RBI declared current account convertibility in the mid-1990s. In 1999-2000, a partial convertibility of capital account was announced, removing thereby all control on inflow of foreign funds but retaining controls on outflows.) such an eventuality is inescapable. In that event the collapse of Argentina in 2001 may be rehearsed in the not too distant future. It is useful to remember that Argentina’s forex reserves of US $ 82 billion disappeared in a matter of single day under the impact of speculative capital transfer.

In the foreseeable short run the FIIs, mostly based in the imperialist countries, and the multinational banking corporations will earn a lot by injecting funds into the underdeveloped countries. Taking advantage of capital market liberalisation they will make inroads deep into financial system of our country, sowing seeds of destabilisation. People of this land will have to face the disruption in economic life which is the logical consequence of inflow of funds, including the hot money movement. The parliamentary parties irrespective of their colour or creed agree on one point, ie. globalisation of the economy – forcing the economy open, for loot and plunder by multinationals. This role of the political parties should be exposed and people be mobilised against those organised forces which nurse the imperialist interests at home.

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