Volume 6, No. 6, June 2005

Trying to encash on the stock market boom before the Harshad Mehta scam, the then Finance Minister Mr Manmohan Singh had said "The Stock market is responding to the economic reforms". But in no time he retracted after the scam was exposed and the stock market crashed and said " the Stock market is no indicator of the economy and I can’t loose my sleep over stock market". This is the typical response of our policy makers. They take credit for things as long as it suits them and disown them the moment they are not moving in their favour.

A similar approach is being taken towards the huge foreign exchange reserves, amounting to US $126 billion, with the government of India. The foreign exchange reserves with the RBI are steeply increasing from the time the present phase of new economic reforms were launched during the Narasimha Rao-Manomohan Singh time. In 1989 our foreign exchange reserves touched rock bottom. They had fallen to a level that could barely last fourteen days and the Government of India had to pledge its gold with the Bank of England to borrow foreign exchange to buy essential imports. After embarking on to this present phase of new economic policies under the auspices of the IMF and World Bank combine, the foreign exchange reserves have been rising continuously. The improvement in the foreign exchange reserves from a bare minimum level (equivalent to two weeks of imports), to the present US $126 billion level (which can last for more than 26 months) is repeatedly claimed by successive governments as their achievement. They are trying to sell this as a success story of the liberalization-privatization-globalization policies. But can be this be said to be a success story? Can this be called an achievement? No it can’t. If we go into the sources and composition of these foreign exchange reserves we will come to know that there is nothing to feel great about it and on the other hand we are paying heavy price for sitting on such reserves.

In the present day of global trade, exports and imports of goods and services are essential for every country. For carrying out trade between two countries each country must have a currency acceptable to both. The currency of one country will not be acceptable to the other country unless either there is a special trade agreement between the two countries like the one India has with Nepal and the erstwhile Soviet Union or there is a common currency between them like the EURO in the European Union countries. Because of its superpower status and also because of its large share in the world trade the US dollar has emerged as the most acceptable currency of the world. Apart from this, SDRs (Special Drawing Rights a currency of the IMF) and gold are also acceptable as a medium of exchange in world trade. Every country must maintain a reserve in the form of these currencies for buying imports. These reserves are known as foreign exchange reserves and will become an asset in the central bank of the respective countries. So foreign exchange reserves means the amount held by the government or the central bank of a country (RBI in the case of India) in the form of US dollars, SDRs and gold. In India at the end of December 2004, the RBI was having foreign exchange reserves of US $126 billion comprising of gold reserves of US $4.352 billion and SDR of US $5 billion and the rest is foreign currency assets.

Apart from the export and import of goods and services, capital will also move across countries as investment. This capital moving across countries will also become an important source of foreign exchange reserves.

In a nutshell, foreign exchange, required by any country, can be earned by it from its exports, from returns (either in the form of interest or profits) on its investment in other countries and it will be spent for buying the imports and for paying capital liabilities. Any country whose earnings are more than its spending can accumulate foreign exchange reserves and such accumulation will represent the sound financial health of that country and any country with surplus foreign exchange can feel proud of its reserves. Can this be the case with India? No it is not. Because India always had trade deficits, which means its imports are always more than its exports. The returns on India’s investments abroad are negligible when compared to its debt payments. In such a case how India has managed to pile up such large foreign exchange reserves is interesting to know.

Our foreign exchange reserves are bulging not because of our earnings from exports but because of borrowings and inflow of foreign capital. Thanks to economic reforms pursued by successive governments to please the international lenders like the IMF, World Bank and other financial institutions there is a regular flow of foreign capital into the country both as debt and as investment. This is what is making our foreign exchange reserves increase. The huge foreign exchange reserves we have is not an asset because it is not created from our earnings but a liability that has emerged out of the foreign capital inflow into the country. The ruling classes are cleverly suppressing this fact and trying to portray rosy picture of this liability. Our present Prime Minister during his previous tenure as finance minister already redefined the word "self sufficiency" as "having enough foreign exchange reserves to pay for the imports" by conveniently ignoring the source of foreign exchange reserves. Going by this definition, India with so much foreign exchange reserves can easily be called a "self-sufficient economy".

Now let us try to understand the exact position of the foreign exchange reserves, its composition and the costs associated with it. As is mentioned above, India always had trade deficits (our export of goods and services are always less than import of goods and services). And this gap has been increasing day by day. Even in the current year our exports and imports for the period April to September are US$ 34,451 million and US $ 51,892 million respectively resulting in a deficit of US $17,441 million.

The following table of Foreign Trade will further highlight this point.

(in US $ million)

So trade is a drain and not a source for foreign exchange reserves. The other source left for foreign exchange reserves is capital inflows into the country. As long as international finance capital finds India as an attractive place to earn profits it will flow into the country and our foreign exchange reserves will continue to swell, and the moment they feel the other way, this inflow will be stopped and the so called strong external sector will burst like a bubble. The foreign capital inflow can be either in the form of investment in setting up of industries here, which is called FDI (Foreign Direct Investment), or in the form of pure speculation in the stock market which is called FIIs (Foreign Institutional Investment) or in the form of deposits by the NRIs (Non Resident Indians).

As for FDI, it is an equity for which we need not pay interest, but there will be an outflow in the form of profits, royalty, technical fee etc. The only advantage of this form of foreign capital over the other forms is that it is a long-term investment and comparatively more stable and can’t be withdrawn overnight and hence not volatile. Yet most of it goes to swallow up indegenouas capital and bring high technology displacing labour. Where as the foreign capital in the form FIIs is purely on speculation and they will not have any productive purpose. Moreover it is more volatile and moves very fast. They will always be on the look out for short term profits and move fast wherever they see an immediate profit. This can be withdrawn overnight leaving the country bankrupt as they have done in Malaysia and many other countries.

With the huge amounts of their investment they are capable of manipulating the stock market to their advantage. They push the market to an artificial level, lure the small investors, and then offload their stocks making big profits that allow the stock market to collapse leaving the small investors bankrupt. They can push the market to whatever level they want. This is what is happening in our stock market for so many years.

The flow of money from FIIs has been rapidly increasing in the recent past. The net equity purchased by FIIs increased to $3.1 billion, $6.6 billion and $8.5 billion respectively in 2002, 2003 and 2004 respectively. The cumulative stock of FIIs investment totals $30.3 billion which is 8% of the total market capitalization at the Bombay Stock Exchange which is around $383.6 billion. But even with this small portion they account for the 38.4% of the transactions at BSE. Another significant fact is that the hold of total foreign capital on India’s top 50 companies has increased from 18% in 2001 to 22% in 2002 and to 30% at the end of 2004. Further if we consider only free floating shares, or shares normally available for trading, the average holding of FIIs will be about 36%. From this it is easy to realize that the sensex is driven neither by the economic fundamentals nor by the profitability of the companies nor by the dividends they give, but only by the outlook of these FIIs. The recent example is that even after such a devastating tragedy of tsunami, which struck on 26th December, the stock market kept on rising and reached record levels. After reaching a record high of 6679 on January 3, 2005 the stock market suddenly collapsed loosing 316 points in a single day on January 5 draining around Rs 60,000 crores from the market. This is not because of any economic reasons, as there is no substantial change in the "fundamentals", but because FIIs offloaded their stocks to book profits.

In case of NRI deposits the government has to pay high interest on these deposits. The present level of interest on these dep-osits is between 2.5% to 4.5% depen-ding on the currency and the tenure. With other concessions it is in fact much higher and well above international rates of interest.

Another source of foreign currency is borrowings by government, Corporates, Banks and other financial institutions which is known as ECBs (External Commercial Borrowings) at commercial rates and the interest rates will range from 5% to 7%.

On the other hand, the RBI would be investing these reserves in the central banks of other countries where it would be earning interest between 1.5% to 2%. Presently the RBI has invested about US $ 30 billions. It means the RBI is paying 4% interest on the deposits and earning only 2% interest. Hence there is a net out flow of 2% on these foreign exchange reserves. The more reserves we have the more cost we have to pay.

Another significant aspect of our foreign exchange reserves is its composition. The following table of foreign capital inflows into our country will give us the clear picture about the nature of the foreign exchange reserves.

 From the above table we can see that in spite of their best efforts and many incentives the ruling classes are not able to attract FDI in significant portion. And what we are getting is either highly volatile portfolio investment from FIIs and high cost deposits from the NRIs. So India’s piling up of foreign exchange reserves instead of giving comfort to its external sector is a burden on the country and economy. The large funds from FIIs is going to make India a vulnerable hot spot in the global market.

Who is going to feel great about such foreign exchange reserves which are not earned but a borrowed? Only the comprador ruling classes and servants of global capital can feel happy about this. Patriotic Indians can’t allow such and undesirable and unwanted burden on their heads. Like the foreign debt the foreign exchange reserves would be confiscated by any people’s government when it seizes power.

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