Should our forex reserves be utilised for infrastructure developement

There have been so many vociferations from various classes of the intelligentsia over the last two to three years on utilisation of our burgeoning forex reserves for infrastructure development. Plans were also mooted to set up a government subsidiary with capital drawn from forex reserves to support infrastructure projects in India and abroad. But is it a rationale act to utilise our forex reserves for internal needs. Why is it that the government and RBI are hesitating to do the same. As on date the forex reserves stand at $316.17 billion which is more than 30% of our GDP Lets delve into the thought process of the Central banker Y.V.Reddy who remains non committal on this issue and as to what are the possible concerns he might have on releasing the forex reserves for national development :

1. Forex reserves can arise in three different ways either through FDI(Foreign Direct Investment) or FII (Foreign Institutional Investments) or RBI's currency market operations.FDI inflows are the more sustainable, permanent form of money flows which actually result in development and growth, enhancing the economic prowess of the country. Therefore inflows in the form of FDI are always encouraged by countries world over. FII inflows also known as "portfolio" flows, on the other hand, are perceived to be "hot" money whose main objective is to take advantage of arbitrage opportunities in different markets for short to medium term gains. These inflows are temporal in nature and shall be the first outflows from any country given a global/domestic crisis scenario. We have historical evidence from the 1997 east asian crisis and collapse of south east asian economies to the latest sub prime crisis that has sent stock markets across the globe into a tailspin.The experience with FII flows have never been stable in the past for any country across the globe as they are always directed towards lucrative/ speculative investment opportunities with a profit motive. The third aspect of building our forex reserves has been through the currency market operations of the RBI by purchasing dollars to keep the exchange rate pegged to the world’s largest reserve currency. Over the years the dollar has considerably declined in tune with the slowdown in the US economy and as a result currencies across the world have been appreciating against the greenback. But however since 70% of global trade is priced in dollar, RBI has been buying dollars form the open market to keep the exchange rate steady and stable to protect its exporters from the vagaries of rupee appreciation.

2. Indian economy has been growing at 7-8% p.a over the last 4-5 years and this had attracted investor attention world over. Our FDI as well as FII flows have increased over the last 4 years with our FII inflows touching $15 billion in Fiscal 2007 buttressed by commendable corporate earnings and positive economic outlook. Despite all this, the two major factors hurting the economy are fiscal deficit and trade deficit. India imports more than it exports. We don’t have a trade surplus on the current account. Our balance of payments position is negative and is expected to rise this year with spiking oil prices. India’s energy and power requirements are huge and rising by the day. Domestic capacities in the oil and gas sector are yet to fully come on steam. We are facing a crisis in agriculture with slowdown in foodgrain production. We are not self sufficient in major essential commodities. All these requirements are being met through imports. The export basket of India also needs to undergo a change in its product mix to cater to the competitive global markets. The economic growth of India has been led by the domestic consumption story. But for this growth to be sustainable its not enough if we keep consuming. We need to produce and produce innovative, value adding products for global consumption. We need to become self sufficient to rely less on imports, produce more with judicious usage of our natural resources and export the surplus for global consumption. This is the most effective way to create a trade surplus. Unlike a Singapore or a China, our forex reserves, whatever be the size, have not been created out of trade surplus. That is also one of the reasons why we have been unable to create a sovereign fund on the lines of China’s sovereign fund managed by Blackstone and Temasek of Singapore. These countries with the help of these sovereign funds have been picking up stakes in developmental projects across Africa to increase their global footprint. Both China and Singapore know that the next phase of growth will emanate from Africa. India has been missing out on this story inspite of sizeable forex reserves to the tune of 30% of our GDP for the simple fact that

a. We need to maintain adequate cushion to meet our import bills of which oil
imports form a significant component, especially in the wake of rising oil prices
b. Our external debt is pegged at 17% of GDP, which also needs to be covered for
through forex reserves
c. FII inflows might reverse any moment given the unstable global environment.
d. None of us want a repeat of the 1991 crisis when he had to pledge our gold to
meet our balance of payments deficit.

At the moment though, RBI has been supporting India Inc’s M&A deals by providing enough foreign exchange to make acquisitions abroad and pursue their ever-increasing shopping list abroad. But to provide foreign exchange to meet internal needs of the country would be possible only when we have a trade surplus and deficits get wiped out completely. The portion of forex reserves that get created out of our trade surplus can alone be utilized for infrastructure development.