India's approach to foreign exchange reserve management, until the balance of payments crisis of 1991 was to maintain an appropriate level of reserves required for importing goods and services. It was defined in terms of number of months of imports equivalent of reserves.
For example, let us say India's import for a year was USD 36 billion and India had a foreign exchange reserve of USD 4.5 billion, then it was expressed as our reserves being the equivalent of one and a half months of imports. Emphasis on import cover constituted the primary concern to managing foreign exchange reserves till 1993-94.
The approach to reserve management underwent a paradigm shift in the mid 90s.
The relevant extracts are:
It has traditionally been the practice to view the level of desirable reserves as a percentage of the annual imports-say reserves to meet three months imports or four months imports. However, this approach would be inadequate when a large number of transactions and payment liabilities arise in areas other than import of commodities.
These started happening with the liberalization that led to foreign investors investing in Indian companies either through the Foreign Institutional Investor (FII) route (Morgan Stanleys of the world investing in Indian stock markets) or through Foreign Direct Investment (FDI) route (Enron investing in Dabhol Power Corporation!!). These were instance of foreign currency coming into the country. For each of these inflows, there will be a future outflow either when the FIIs repatriate their investments or the FDIs taking back profits of their investments.
In addition, liabilities may arise either for repaying loans or paying interest on loans. The new approach was aimed at determining the level of forex reserve, by paying attention to the loan repayment and interest payment obligations in addition to the level of imports.
In addition, with the opening up of the economy since the early 90s, the impact of changes in global currency markets is bound to affect Indian shores as well. Further, emphasis was placed on gaining the ability to take care of the seasonal factors in any balance of payments (foreign exchange inflows - foreign exchange outflows) transaction with reference to the possible uncertainties in the monsoon conditions of India and to counter speculative tendencies or anticipatory actions amongst players in the foreign exchange market.
For example, let us say India's import for a year was USD 36 billion and India had a foreign exchange reserve of USD 4.5 billion, then it was expressed as our reserves being the equivalent of one and a half months of imports. Emphasis on import cover constituted the primary concern to managing foreign exchange reserves till 1993-94.
The approach to reserve management underwent a paradigm shift in the mid 90s.
The relevant extracts are:
It has traditionally been the practice to view the level of desirable reserves as a percentage of the annual imports-say reserves to meet three months imports or four months imports. However, this approach would be inadequate when a large number of transactions and payment liabilities arise in areas other than import of commodities.
These started happening with the liberalization that led to foreign investors investing in Indian companies either through the Foreign Institutional Investor (FII) route (Morgan Stanleys of the world investing in Indian stock markets) or through Foreign Direct Investment (FDI) route (Enron investing in Dabhol Power Corporation!!). These were instance of foreign currency coming into the country. For each of these inflows, there will be a future outflow either when the FIIs repatriate their investments or the FDIs taking back profits of their investments.
In addition, liabilities may arise either for repaying loans or paying interest on loans. The new approach was aimed at determining the level of forex reserve, by paying attention to the loan repayment and interest payment obligations in addition to the level of imports.
In addition, with the opening up of the economy since the early 90s, the impact of changes in global currency markets is bound to affect Indian shores as well. Further, emphasis was placed on gaining the ability to take care of the seasonal factors in any balance of payments (foreign exchange inflows - foreign exchange outflows) transaction with reference to the possible uncertainties in the monsoon conditions of India and to counter speculative tendencies or anticipatory actions amongst players in the foreign exchange market.
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