The government and RBI must work in tandem to make rupee fully convertible

India’s foreign exchange reserves crossing $400 billion mark may be symbolic for many, but for traditional economists, it depicts the strength and resilience of a country’s economy and its currency. Most conservative policy analysts use the burgeoning foreign exchange assets as a leading economic indicator that portrays good times ahead for investors and market players in the medium to long term.

There’s no reason for anyone to disbelieve that the country’s foreign exchange reserves at $400 billion is a source of confidence for a country on the go. This is especially so for India that had to once pledge its gold with Bank of England and Switzerland in the early 1990s to fund its oil import bill and meet non-oil import obligations. The country has come a long way since then. In recent times, the worst-case scenario was when foreign exchange reserves depleted to $270 billion in 2012 as a direct impact of global melt down during the UPA-II regime. At best, India’s handling of foreign exchange reserves can be described as a hugely conservative, no-risk business. Given such an approach by successive RBI governors and finance ministers, it’s no surprise that the returns on these reserves were a measly 0.7 per cent as against 1.9 per cent recorded in the past.

Given the piquant situation faced by India during VP Singh and later Chandrashekhar’s short regimes, foreign reserves were mostly held for long in US dollars. Only in last 15 odd years, diversification in portfolio was pursued to include hard currencies like euros, pound sterling, yen and reminbi. Gold, special drawing rights (SDRs) with IMF and rupee holdings by IMF, among others, formed other assets in which India has invested its reserves. The quality of foreign exchange assets is an issue that’s hotly debated in the world of financial sector professionals. While capital inflows — both foreign direct investment and foreign portfolio investments — contributed largely to the bulge in India’s assets, there’s a growing concern about not being able to build export surpluses. For this to happen, a medium term plan needs to be put in place given the huge trade deficit of $150 billion that India reports. Unless our products and services get accepted globally in terms of quality and price competitiveness, this cannot happen. One of the options could perhaps be devaluing the rupee, but unless the industry and exporters get aggressive, devaluation alone cannot make Indian exports sustainable.

Concomitantly, RBI will have to pursue a more flexible currency policy than merely limiting rupee to oscillate within a predetermined band. The government and the central bank must also work in tandem to make rupee fully convertible, both on capital and revenue accounts, to enhance its acceptability as a reserve currency by major trading partners. This will also lay the foundation to make Indian rupee part of global currencies after renminbi was included into the IMF bouquet recently. India may also have to chart out a plan to leverage foreign exchange reserves to pursue its offensive and defensive economic interests globally. For example, it is tempting to believe that India can be part of the elite group of nations that has set up sovereign wealth funds to make strategic and commercial investments internationally. Though, India may not be anywhere near China in this game, she has to begin somewhere. Energy assets could be one area where a dedicated fund could operate. Secondly, investments in Africa and Latin America will have to be considered on priority basis as a win-win deal for both sides.