Contents

FOREX RESERVES OF INDIA...................................................................................2

1. WHAT ARE FOREX RESERVES......................................................................2
2. WHY COUNTRIES HOLD FOREX RESERVES...................................................2
3. WHAT IS THE APPROPRIATE LEVEL OF FOREX RESERVES??.........................4
4. WHO MAINTAINS FOREX RESERVES??..........................................................5
5. WHY FOREX RESERVES??.............................................................................5
6. COST TO MAINTAIN FOREIGN RESERVES.....................................................6
7. IMPACT OF RESERVES ON BUSINESSES.......................................................6
8. LIST OF 10 COUNTRIES HAVING THE MOST FOREIGN RESERVES.................7
9. RESERVE BANK OF INDIA.............................................................................7
10. OBJECTIVES OF RESERVE MANAGEMENT..................................................7
11. LEGAL FRAMEWORKS AND POLICIES........................................................8
12. MOVEMENT OF RESERVES........................................................................8
13. EXTERNAL LIABILITIES VIS –A- VIS FOREIGN EXCHANGE RESERVES.......12
14. ADEQUACY OF RESERVES.......................................................................12
15. MANAGEMENT OF GOLD RESERVES........................................................13
16. INVESTMENT PATTERN AND EARNINGS OF THE FOREIGN CURRENCY
ASSETS.............................................................................................................13
17. OTHER RELATED ASPECTS......................................................................14
18. BIBLIOGRAPHY........................................................................................15
BIBLIOGRAPHY

GROUP I: FOREX RESERVES OF INDIA Page 1

FOREX RESERVES OF INDIA

1. WHAT ARE FOREX RESERVES

Conceptually, a unique definition of forex reserves is not available as
there have been divergence of views in terms of coverage of items,
ownership of assets, liquidity aspects and need for a distinction between
owned and non-owned reserves Nevertheless, for policy and operational
purposes, most countries have adopted the definition suggested by the
International Monetary Fund (Balance of Payments Manual, and
Guidelines on Foreign Exchange Reserve Management, 2001); which
defines reserves as external assets that are readily available to and
controlled by monetary authorities for direct financing of external
payments imbalances, for indirectly regulating the magnitudes of such
imbalances through intervention in exchange markets to affect the
currency exchange rate, and/or for other purposes.

The standard approach for measuring international reserves takes into

account the unencumbered international reserve assets of the monetary
authority; however, the foreign currency and the securities held by the
public including the banks and corporate bodies are not accounted for in
the definition of official holdings of international reserves.
In India, the Reserve Bank of India Act 1934 contains the enabling
provisions for the RBI to act as the custodian of foreign reserves, and
manage reserves with defined objectives. The powers of being the
custodian of foreign reserves is enshrined, in the first instance, in the
preamble of the Act. The ‘reserves’ refer to both foreign reserves in the
form of gold assets in the Banking Department and foreign securities held
by the Issue Department, and domestic reserves in the form of ‘bank
reserves’.

The composition of foreign reserves is indicated, a minimum reserve

system is set out, and the instruments and securities in which the
country’s reserves could be deployed are spelt out in the relevant
Sections of the RBI Act.

In brief, in India, what constitutes forex reserves; who is the custodian

and how it should be deployed are laid out clearly in the Statute, and in
an extremely conservative fashion as far as management of reserves is
concerned. In substantive terms, RBI functions as the custodian and
manager of forex reserves, and operates within the overall policy
framework agreed upon with Government of India.

2. WHY COUNTRIES HOLD FOREX RESERVES

GROUP I: FOREX RESERVES OF INDIA Page 2

Technically, it is possible to consider three motives i.e., transaction,
speculative and precautionary motives for holding reserves. International
trade gives rise to currency flows, which are assumed to be handled by
private banks driven by the transaction motive. Similarly, speculative
motive is left to individual or corporates. Central bank reserves, however,
are characterized primarily as a last resort stock of foreign currency for
unpredictable flows, which is consistent with precautionary motive for
holding foreign assets. Precautionary motive for holding foreign currency,
like the demand for money, can be positively related to wealth and the
cost of covering unplanned deficit, and negatively related to the return
from alternative assets.

From a policy perspective, it is clear that the country benefits through

economies of scale by pooling the transaction reserves, while subserving
the precautionary motive of keeping official reserves as a ‘war chest’.
Furthermore, forex reserves are instruments to maintain or manage the
exchange rate, while enabling orderly absorption of international money
and capital flows. In brief, official reserves areheld for precautionary and
transaction motives keeping in view the aggregate of national interests,
to achieve balance between demand for and supply of foreign currencies,
for intervention, and to preserve confidence in the country’s ability to
carry out external transactions.

Reserve assets could be defined with respect to assets of monetary

authority as the custodian, or of sovereign government as the principal.
For the monetary authority, the motives for holding reserves may not
deviate from the monetary policy objectives, while for government; the
objectives of holding reserves may go beyond that of the monetary
authorities. In other words, the final expression of the objective of holding
reserve assets would be influenced by the reconciliation of objectives of
the monetary authority as the custodian and the government as principal.
There are cases, however, when reserves are used as a convenient
mechanism for government purchases of goods and services, servicing
foreign currency debt of government, insurance against emergencies, and
in respect of a few, as a source of income.

What are the dominant policy objectives in regard to forex reserves in

India? It is difficult to lay down objectives in very precise terms, nor is it
possible to order all relevant objectives by order of precedence in view of
emerging situations which are described later. For the present, a list of
objectives in broader terms may be encapsulated viz.

(a) Maintaining confidence in monetary and exchange rate policies,

(b) Enhancing capacity to intervene in forex markets,
(c) Limiting external vulnerability by maintaining foreign currency
liquidity to absorb shocks during times of crisis including national
disasters or emergencies;

GROUP I: FOREX RESERVES OF INDIA Page 3

 (d) Providing confidence to the markets especially credit rating
agencies that external obligations can always be met, thus reducing
the overall costs at which forex resources are available to all the
market participants, and
(e) Incidentally adding to the comfort of the market participants, by
demonstrating the backing of domestic currency by external assets.

At a formal level, the objective of reserve management in India could be

found in the RBI Act, where the relevant part of the preamble reads as ‘to
use the currency system to the country’s advantage and with a view to
securing monetary stability’. This statement may be interpreted to hold
that monetary stability means internal as well as external stability;
implying stable exchange rate as the overall objective of the reserve
management policy. While internal stability implies that reserve
management cannot be isolated from domestic macroeconomic stability
and economic growth, the phrase ‘to use the currency system to the
country’s advantage’ implies that maximum gains for the country as a
whole or economy in general could be derived in the process of reserve
management, which not only
provides for considerable flexibility to reserve management practice, but
also warrants a very dynamic view of what the country needs and how
best to meet the requirements. In other words, the financial return or
trade off between financial costs and benefits of holding and maintaining
reserves is not the only or the predominant objective in management of
reserves.

3. WHAT IS THE APPROPRIATE LEVEL OF FOREX

RESERVES??

Basic motives for holding reserves do result in alternative frameworks for

determining appropriate level of foreign reserves. Efforts have been made
by economists to present an optimising framework for maintaining
appropriate level of foreign reserves and one viewpoint suggests that
optimal reserves pertain to the level at which marginal social cost equals
marginal social benefit. Optimal level of reserves has also been indicated
as the level where marginal productivity of reserves plus interest earned
on reserve assets equals the marginal productivity of real resources and
this framework encompasses exchange rate stability as the predominant
objective of reserve management. Since the underlying costs and benefits
of reserves can be measured in several ways, these approaches to
optimal level provide ample scope for developing a host of indicators of
appropriate level of reserves. It is possible to identify four sets of
indicators to assess adequacy of reserves, and each of them do provide

GROUP I: FOREX RESERVES OF INDIA Page 4

an insight into adequacy though none of them may by itself fully explain
adequacy.

First, the money based indicators including reserve to broad money or

reserves to base money which provide a measure of potential for resident
based capital flight from currency. An unstable demand for money or the
presence of a weak banking system may indicate greater probability of
such capital flights. Money based indicators, however, suffer from several
drawbacks. In countries, where money demand is stable and confidence
in domestic currency high, domestic money demand tends to be larger
and reserves over money ratios, relatively small. Therefore, while a
sizable money stock in relation to reserves, prima facie, suggests a large
potential for capital flight out of money, it is not necessarily a good
predictor of actual capital flight. Money based indicators also do not
capture comprehensively the potential for domestic capital flight.
Moreover, empirical studies find a weak relationship between money
based indicator and occurrence and depth of international crises.

Secondly, trade based indicators; usually the import-based indicators

defined in terms of reserves in months of imports provide a simple way of
scaling the level of reserves by the size and openness of the economy. It
has a straightforward interpretation- a number of months a country can
continue to support its current level of imports if all other inflows and
outflows cease. As the measure focuses on current account, it is relevant
for small economies, which have limited access and vulnerabilities to
capital markets. For substantially open economies with a sizable capital
account, the import cover
measure may not be appropriate.

Thirdly, debt based indicators are of recent origin; they appeared with
episodes of international crises, as several studies confirmed that
reserves to short term debt by remaining maturity is a better indicator of
identifying financial crises. Debt-based indicators are useful for gauging
risks associated with adverse developments in international capital
markets. Since short-term debt by remaining maturity provides a
measure of all debt repayments to nonresidents over the coming year, it
constitutes a useful measure of how quickly a country would be forced to
adjust in the face of capital market distortion. Studies have shown that it
could be the single most important indicator of reserve adequacy in
countries with significant but uncertain access to capital markets.

Fourthly, more recent approaches to reserve adequacy have suggested a

combination of current capital accounts as the meaningful measure of
liquidity risks. Of particular interest, is the Guidotti Rule, which has
received wide appreciation form many central bankers including Alan
Greenspan, postulates that the ratio of short term debt augmented with a
projected current account deficit (or another measure of expected

GROUP I: FOREX RESERVES OF INDIA Page 5

borrowing) could serve useful an indicator of how long a country can
sustain external imbalance without resorting to foreign borrowing. As a
matter of practice, the Guidotti Rule suggests that the countries should
hold external assets sufficient to ensure that they could live without
access to new foreign borrowings for up to twelve months. This implies
that the usable foreign exchange reserves should exceed scheduled
amortisation of foreign currency debts (assuming no rollover during the
following year).

4. WHO MAINTAINS FOREX RESERVES??

The monetary authority and central bank of each country, like the
Reserve Bank of India (RBI), the Federal Reserve of the US and the
People’s Bank of China, maintain the forex reserves of the country. Then
there are other big investment funds that some countries like Abu Dhabi
and Singapore maintain. Many argue that these should be included in the
forex reserve count. India has also been speaking about setting up such
an investment fund.

5. WHY FOREX RESERVES??

These are maintained primarily to protect a country’s domestic currency
from losing its value or, in other words, to avoid a currency crisis. Just like
other goods, a country’s currency can lose its value when demand for it
falls or when there is excess supply of it. Such a situation may arise when
investors do not want to stay invested in that country and want to
transfer their funds out of that country or from the currency of that
country. For example, suppose due to any reason a foreign investor wants
to sell out his equity holdings in Indian companies and want to transfer
these funds to the USA. In this case, he or she would convert the Indian
rupees received by selling the equities into US dollars. If a large number
of investors do this simultaneously while the reverse (fresh investments
by foreign investors into Indian equities) is not happening, it will lead to a
fall in the value of the rupee. Which is to say, it would lead to the
depreciation of the Indian rupee against the dollar and there is a net
outflow of dollars? Sometimes this depreciation (or need for devaluation)
could be large in magnitude. Such instability in exchange rates and loss
of confidence in the currency have an effect on the economy. So to avoid
such sudden changes and to maintain confidence in the currency,
reserves are maintained. Forex reserves are also maintained to achieve
some level of exchange rates. These levels are determined based on the
policies and objectives of the country. Generally, developing economies,
in order to increase exports and decrease imports, try to keep their
exchange rates low (so that a given sum of foreign currency can buy
more goods from them) and the value of their currency low and in order
to do so build up reserves.
Forex reserves are generally deployed in low-risk liquid assets having
sovereign guarantee. Reserves are often advanced as loans to other

GROUP I: FOREX RESERVES OF INDIA Page 6

countries, other central banks, Bank for International Settlements and
highly rated foreign commercial banks. Foreign exchange reserves are
also used to manage liquidity in the system.

6. COST TO MAINTAIN FOREIGN RESERVES

There are costs associated with maintaining these reserves. Investments
made by foreign funds in a country tend to earn much higher returns than
what a central bank gets by investing its reserves. For example, an FII
coming in earns much higher rates of return by investing in equities, but
the government earns only a nominal (or very low) rate of return by
investing in debt instruments of other central banks.
Forex reserves are kept in highly liquid assets in order to fulfill needs of
foreign exchange when it arises. The government cannot invest these
reserves in projects or physical infrastructure. So there is an opportunity
cost of holding the reserves. The reserves also impact government policy
negatively in the sense that it has to consider the effects of policy
changes on its reserves. For example, in October 2007, Securities and
Exchange Board of India (SEBI) came up with a new ruling regarding
participatory notes and FIIs, but were forced to make necessary
amendments because of the threat of FIIs pulling out.
There is also another significant management activity, which is referred
to in economic terms as sterilization. Suppose an investor wants to invest
in India and brings in US dollars. However, in order to buy assets in India,
they need to make payments in rupees. So they exchange their dollars
with RBI for rupees, which they then put into the Indian economy and
purchase assets. In this whole transaction, the quantity of Indian currency
(money supply) has increased in the Indian economy. To negate this
increase in money supply, the RBI can issue debt or bonds to mop up that
amount of currency from the system. This method of reducing the
increased money supply in market is called sterilization. However,
generally interest rates are relatively higher on such bonds and debt
relative to what the RBI earns by investing reserves. Also, partial or
incomplete sterilization could lead to inflation.

7. IMPACT OF RESERVES ON BUSINESSES

As far as businesses are concerned, in the short run they definitely
benefit from larger forex reserves as they can access more liquidity if
there is ineffective, partial or no sterilization. Increased liquidity also
creates demand in the economy. Due to build-up of such reserves,
volatility in exchange rates is often checked, which provides a conducive
environment to businesses. Stable exchange rates allow exporters and
importers to engage in futures contracts. Also, the expectation of the
currency and the economy being crisis-proof raises confidence among
investors.

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However, this can have repercussions as well. Often businesses are badly
hurt when there is a bursting of bubbles in asset markets. Inflation is also
not good for businesses in the medium to long run. The government may
not also be able to provide adequate support to businesses due to net
loss of earnings. There may be cuts in subsidies, investments and other
expenditure, which may have an effect too.

8. LIST OF 10 COUNTRIES HAVING THE MOST FOREIGN

RESERVES

RA NAME OF THE FOREIGN EXCHANGE RESERVES FIGURES AS

NK COUNTRY OF
( US $ MILLIONs)

WORLD (Sum of all 8,753,689

countries)

1 People's Republic of 2,273,000 SEP 2009

China

2 Japan 1,052,600 NOV 2009

3 Russia 447,776 MAY 2009

4 Saudi Arabia 395,467 NOV 2009

5 Republic of China 347,190 DEC 2009

(Taiwan)

6 India 287,374 NOV 2009

7 South Korea 270,900 OCT 2009

8 Hong Kong 240,100 NOV 2009

9 Brazil 238,000 JULY 2009

10 Germany 184,167 NOV 2009

9. RESERVE BANK OF INDIA

Based on a review of the main policy and operational matters relating to

the management of the reserves undertaken in 2003, the Reserve Bank
of India had decided to compile and make public half-yearly reports on
management of foreign exchange reserves for bringing about more
transparency and enhancing the level of disclosure. The first such report
with reference to the position as on September 30, 2003 was placed in

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the public domain on February 3, 2004. These reports are now being
prepared half yearly with reference to the position as of 31st March and
30th September each year with a time lag of about three months. The
present report is the 12th in the series with reference to the position as
on March 31, 2009. The report is divided into three parts: Part I gives the
objectives of reserves management, statutory provisions, movement of
reserves and other useful information like the external liabilities vis-à-vis
the foreign exchange reserves, prepayment / repayment of external debt,
Financial Transaction Plan (FTP) of the IMF, adequacy of reserves, etc.
Overview of the risk management practices followed by the Reserve Bank
of India in relation to reserves management is covered in Part II. Part III of
the report provides information on transparency and disclosure practices
followed by the RBI with regard to the reserves management.

10.OBJECTIVES OF RESERVE MANAGEMENT

The guiding objectives of foreign exchange reserves management in India

are similar to many central banks in the world. The demands placed on
the foreign exchange reserves may vary widely depending upon a variety
of factors including the exchange rate regime adopted by the country, the
extent of openness of the economy, the size of the external sector in a
country's GDP and the nature of markets operating in the country. Even
within this divergent framework most countries have adopted the primary
objective of reserve management as preservation of the long-term value
of the reserves in terms of purchasing power and the need to minimise
risk and volatility in returns. India is not an exception in this regard. While
safety and liquidity constitute the twin objectives of reserve management
in India, return optimisation becomes an embedded strategy within this
framework.

11.LEGAL FRAMEWORKS AND POLICIES

The Reserve Bank of India Act, 1934 provides the overarching legal
framework for deployment of the foreign currency assets (FCA) and gold
defining the broad parameters in respect of currencies, instruments,
issuers and counterparties. The essential legal framework for reserves
management is provided in sub-sections 17 (6A), 17(12), 17(12A), 17(13)
and 33(1) of the above Act. In brief, the law broadly permits the following
investment categories:
a. Deposits with other central banks and the Bank for International
Settlements (BIS);
b. Deposits with foreign commercial banks;
c. Debt instruments representing sovereign/sovereign-guaranteed
liability with residual maturity for the debt papers not exceeding
10 years;

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 d. Other instruments / institutions as approved by the Central
Board of the Reserve Bank in accordance with the provisions of
the Act; and
e. Dealing in certain types of derivatives.
f. RBI has framed appropriate guidelines stipulating stringent
criteria for issuers/counterparties/investments with a view to
enhancing the safety and liquidity aspects of the reserves.

1. MOVEMENT OF RESERVES

a. REVIEW OF GROWTH OF RESERVES SINCE 1991

India’s foreign exchange reserves have grown significantly since 1991.

The reserves, which stood at US$ 5.8 billion at end-March 1991 increased
gradually to US$ 25.2 billion by end-March 1995. The growth continued in
the second half of the 1990s with the reserves touching the level of US$
38.0 billion by end-March 2000. Subsequently, the reserves rose to US$
113.0 billion by end-March 2004, US$ 199.2 billion by end-March 2007
and further to US$ 309.7 billion by end-March 2008. Thereafter the
reserves declined to US$ 252.0 billion by end March 2009.

TABLE – 1 Movement in Reserves

DATE FCA SDR GOLD RTP FOREX RESERVES

31-Mar-06 145108 3(2) 5755 756 151622
30-Sep-06 158340 1(1) 6202 762 165305
31-Mar-07 191924 2(1) 6784 469 199179
30-Sep-07 239954 2(1) 7367 438 247761
31-Mar-08 299230 18 ( 11 ) 10039 436 309723
30-Sep-08 277300 4(2) 8565 467 286336
31-Mar-09 241426 1(1) 9577 981 251985

Note: 1. FCA (Foreign Currency Assets): FCAs are maintained as a multi currency
portfolio comprising major currencies, such as, US dollar, Euro, Pound
Sterling, Japanese yen, etc. and is valued in terms of US dollars.
2. SDR (Special Drawing Rights): Values in SDR have been indicated in
parentheses.
3. Gold: Physical stock has remained unchanged at approximately 357 tonnes.
4. RTP refers to the Reserve Tranche Position in the IMF.

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 CHART – 1

Although both US dollar and Euro are intervention currencies and the
Foreign Currency Assets are maintained in major currencies like US
Dollar, Euro, Pound Sterling, Australian Dollar, Japanese Yen etc., the
foreign exchange reserves are denominated and expressed in US Dollar
only. The foreign exchange reserve data prior to 2002-03 do not include
the Reserve Tranche Position (RTP) in the International Monetary Fund
(IMF). Movements in the FCA occur mainly on account of purchases and
sales of foreign exchange by RBI in the foreign exchange market in India.
In addition, income arising out of the deployment of foreign exchange
reserves is also held in the portfolio of the reserves. External aid receipts
of the Central Government also flow into the reserves. The movement of
the US dollar against other currencies in which FCA are held also impact
the level of reserves in US dollar terms.

b. SOURCES OF ACCRETION TO THE RESREVES

Table 2 details the major sources of accretion to foreign exchange

reserves during the period from March 1991 to March 2009

Table 2: Sources of Accretion to Foreign Exchange Reserves since

1991

US $ BILLION
1991-92 to 2008-09 up to
ITEMS March end
Reserve outstanding as on end March
A 91 5.8
B. I Current Account balance -81.6
B.
II Capital Account net ( a to e ) 331.7
a. Foreign Investments of which 155.2
i. FDI 75.8
ii. FII 51.6
b. NRI Deposits 34.1
c. External Assistance 18.6
d. External Commercial Borrowings 68.2
e. Other items in Capital acount 55.6
B.
III Valuation change -4
Total ( A + B.I + B. II + B. III) 252

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Table 3 provides details of variation in foreign exchange reserves during
2008-09 and the corresponding period of the previous year. The foreign
exchange reserves (including the valuation effects) declined by US$
57,738 million during 2008-09 as against an increase of US$ 110,544
million during 2007-08. On balance of payments basis (i.e., excluding
valuation effects), the foreign exchange reserves declined by US$ 20,080
million during 2008- 09 as against an increase of US$ 92,164 million
during 2007-08. The valuation loss explained 65.2 per cent of decline in
reserves during 2008-09. Apart from current account deficits, outflows
under FIIs, short-term trade credit to India and banking capital were the
other major sources contributing to decline in foreign exchange reserves
during the financial year 2008-09.

Table 3: Sources of Variation in Foreign Exchange Reserves

US $ BILLION
ITEMS 2007-08 2008-09
I Current Account balance -17 -29.8
II Capital Account net ( a to f ) 109.2 9.7
a Foreign Investments net ( i
. + ii ) 45 3.5
i. Foreign Direct Investment 15.4 17.5
ii Portfolio investment of
. which 29.6 -14
FII 20.3 -15
ADRs / GDRs 8.8 1.2
b External Commercial
. Borrowings 22.6 8.2
c
. Banking Capital 11.8 -3.4
of which : NRI deposits 0.2 4.3
d
. Short term Trade credit 17.2 -5.8
e
. External Assistance 2.1 2.6
Other items in Capital
f. acount 10.6 4.7
III Valuation change 18.4 -37.7
Total ( I + II + III) 110.5 -57.7

An analysis of the sources of reserves accretion during the entire reform

period from 1991 onwards reveals that the increase in foreign exchange
reserves has been facilitated by an increase in net foreign direct
investment (FDI) from US $ 129 million in 1991-92 to US$ 17.5 billion in

GROUP I: FOREX RESERVES OF INDIA Page 12

2008-09. FII investments in the Indian capital market, which commenced
in January 1993, have shown significant increase over the subsequent
years. Cumulative net FII investments increased from US$ 1 million at
end-March 1993 to US$ 51.6 billion at end-March 2009. The net outflows
of US$ 15.0 billion by FIIs led to decline in cumulative portfolio stock to
US$ 79.4 billion at end-March 2009 from US$ 94.5 billion at end-March
2008. Outstanding NRI deposits increased from US$ 14.0 billion at end-
March 1991 to US$ 43.7 billion as at end-March 2008. As at end-March
2009, the outstanding NRI deposit stood at US$ 41.3 billion. Turning to
the current account, India’s exports, which were US$ 18.3 billion during
1991-92 increased to US$ 166.2 billion in 2007-08. During 2008-09,
India’s exports amounted to US $ 175.2 billion. India’s imports which were
US $ 24.1 billion in 1991-92 increased to US $ 257.8 billion in 2007-08.
During 2008-09, India’s imports amounted to US $ 294.6 billion. Invisibles,
in particular, private remittances have contributed significantly to the
current account. Net invisibles inflows, comprising mainly of private
transfer remittances and services increased from US$ 1.6 billion in 1991-
92 to US$ 89.6 billion in 2008-09. India’s current account balance which
was in deficit at 3.0 per cent of GDP in 1990-91 turned into a surplus of
0.7 per cent in 2001-02 and further a surplus of 1.2 per cent in 2002-03. A
surplus of US $ 14.1 billion was posted in the current account during the
financial year 2003-04, driven mainly by the surplus in the invisibles
account. However, this was not sustained during 2004-05, with the
current account posting a deficit of US$ 2.5 billion, driven mainly by the
surge in oil prices in the international market. During 2005-06 and 2006-
07, current account deficit widened further and remained around 1 per
cent of GDP, driven mainly by strong import demand, both oil and non-oil.
The current account deficit further increased to US $ 17.0 billion or 1.5
per cent of GDP in 2007-08 and again to US$ 29.8 billion or 2.6 per cent
of GDP in 2008-09 led by high import payments.

1. EXTERNAL LIABILITIES VIS –A- VIS FOREIGN EXCHANGE

RESERVES

The accretion of foreign exchange reserves needs to be seen in the light

of total external liabilities of the country. India’s International Investment
Position (IIP), which is a summary record of the stock of country’s external
financial assets and liabilities, is available as of end December 2008.

Table 4: International Investment Position of India

(US $ billion)
ITEM DECEMBER 2008 (Provisional)
A. Total Foreign Assets 340.2

GROUP I: FOREX RESERVES OF INDIA Page 13

i. Direct Investment Abroad 61.8
ii. Portfolio Investment 0.6
iii. Other Investments 21.9
iv. Foreign Exchange Reserves 255.9
B. Total Foreign Liabilities 420.3
i. Direct Investment in India 123.3
ii. Portfolio Investment 93.4
iii. Other Investments 203.6
Net Foreign Liabilities (B-A) 80.1

2. ADEQUACY OF RESERVES

Adequacy of reserves has emerged as an important parameter in gauging

its ability to absorb external shocks. With the changing profile of capital
flows, the traditional approach of assessing reserve adequacy in terms of
import cover has been broadened to include a number of parameters
which take into account the size, composition and risk profiles of various
types of capital flows as well as the types of external shocks to which the
economy is vulnerable. The High Level Committee on Balance of
Payments, which was chaired by Dr. C. Rangarajan, erstwhile Governor of
the Reserve Bank of India, had suggested that, while determining the
adequacy of reserves, due attention should be paid to payment
obligations, in addition to the traditional measure of import cover of 3 to 4
months. In 1997, the Report of Committee on Capital Account
Convertibility under the chairmanship of Shri S.S.Tarapore, erstwhile
Deputy Governor of the Reserve Bank of India suggested alternative
measures of adequacy of reserves which, in addition to trade- based
indicators, also included money-based and debt-based indicators. Similar
views have been held by the Committee on Fuller Capital Account
Convertibility (Chairman: Shri S.S.Tarapore, July 2006).
In the recent period, assessment of reserve adequacy has been
influenced by the introduction of new measures. One such measure
requires that the usable foreign exchange reserves should exceed
scheduled amortisation of foreign currency debts (assuming no rollovers)
during the following year. The other one is based on a "Liquidity at Risk"
rule that takes into account the foreseeable risks that a country could
face. This approach requires that a country's foreign exchange liquidity
position could be calculated under a range of possible outcomes for
relevant financial variables, such as, exchange rates, commodity prices,
credit spreads etc. Reserve Bank of India has been undertaking exercises
based on intuition and risk models to estimate "Liquidity at Risk (LAR)" of
the reserves.

The traditional trade-based indicator of reserve adequacy, viz, import

cover of reserves, which fell to a low of 3 weeks of imports at end-

GROUP I: FOREX RESERVES OF INDIA Page 14

December 1990, rose to 11.5 months of imports at end-March 2002 and
increased further to 14.2 months of imports or about five years of debt
servicing at end-March 2003. At end-March 2004, the import cover of
reserves was 16.9 months, which came down to 14.4 months as at end-
March 2008 and further to 10.3 months as at end-March 2009. The ratio
of short-term debt* to the foreign exchange reserves declined from 146.5
per cent at end-March 1991 to 12.5 per cent as at end-March 2005, but
increased slightly to 12.9 per cent as at end-March 2006. With expansion
in the coverage of short-term debt, the ratio further increased to 14.1 per
cent at end-March 2007, to 15.2 per cent at end-March 2008 and then to
19.6 per cent at end-March 2009. The ratio of volatile capital flows
(defined to include cumulative portfolio inflows and short-term debt) to
the reserves declined from 146.6 per cent as at end-March 1991 to 46.2
per cent as at end March 2007. The ratio, which had declined to 45.4 per
cent at end-March 2008, increased to 51.1 per cent as at end-March
2009.

3. MANAGEMENT OF GOLD RESERVES

The Reserve Bank holds about 357 tonnes of gold forming about 3.8 per
cent of the total foreign exchange reserves in value terms as on March
31, 2009. Of these, 65 tonnes are being held abroad since 1991 in
deposits / safe custody with the Bank of England and the BIS.

4. INVESTMENT PATTERN AND EARNINGS OF THE FOREIGN

CURRENCY ASSETS

The foreign currency assets are invested in multi-currency, multi-asset

portfolios as per the existing norms which are similar to the best
international practices followed in this regard. As at end-March 2009, out
of the total foreign currency assets of US$ 241.4 billion, US$ 134.8 billion
was invested in securities, US $ 101.9 billion was deposited with other
central banks, BIS and the IMF and US$ 4.7 billion was in the form of
deposits with foreign commercial banks / funds placed with the External
Asset Managers (EAMs).

A small portion of the reserves is assigned to the EAMs with the objective
of gaining access to and delivering benefit from their expertise and
market research.

GROUP I: FOREX RESERVES OF INDIA Page 15

 Table 5: Deployment Pattern of Foreign Currency Assets

As on September
As on March 31, 2009 30, 2008
Foreign Currency
Assets 2,41,426 2,77,300
i. Securities 1,34,792 1,11,287
Deposits with other
central banks, BIS &
ii. IMF 1,01,906 1,60,587
Deposits with foreign
commercial banks /
iii. funds placed with EAMs 4,728 5,426

The rate of earnings on foreign currency assets and gold, after accounting
for depreciation, increased from 4.6 per cent in July 2006 - June 2007 to
4.8 per cent in July 2007 - June 2008.

5. OTHER RELATED ASPECTS

a) PRE PAYMENT

The significant increase in forex reserves enabled prepayment of certain

high-cost foreign currency loans of the Government of India from the
Asian Development Bank (ADB) and the International Bank for
Reconstruction and Development (IBRD) / World Bank amounting to US$
3.03 billion during February 2003. During 2003-04, prepayment of certain
high cost loans to the IBRD and the ADB amounting to US$ 2.6 billion was
made by the Government. Additionally, prepayment of bilateral loans
amounting to US$ 1.1 million was also made. Thus, the total quantum of
prepayments was of the order of US$ 3.7 billion during 2003-04. During
2004-05, prepayment of bilateral loans to the tune of US$ 30.3 million
was made. During 2006-07, there was only one prepayment of US$ 58.7
million in the month of April 2006. There was no pre-payment of any debt
during 2007-08 and 2008-09.

b) FINANCIAL TRANSACTION PLAN (FTP) OF THE IMF

International Monetary Fund (IMF) designated India as a creditor under its

Financial Transaction Plan (FTP) in February 2003. In terms of this
arrangement, India participated in the IMF’s financial support to Burundi
in March-May 2003 with a contribution of SDR 5 million and to Brazil in
June-September 2003 with SDR 350 million. In December 2003, SDR 43
million was made available to Indonesia under the FTP. During 2004-05,

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SDR 61 million was made available under the FTP to countries like
Uruguay, Haiti, Dominican Republic and Sri Lanka. During May-June 2005,
SDR 34 million was made available to Turkey and Uruguay. During 2008-
09, SDR 317 million was made available to countries like Bangladesh,
Turkey and Pakistan. Further, during March-June 2009, SDR 86 million was
made available to Georgia and SDR 130 million to Romania. Thus, the
total purchase transactions amounted to SDR 1026 million as at the end
of June 2009. India was included in repurchase transactions of the FTP
since November 2005. There were 21 repurchase transactions during the
period from November 2005 to March 2009 totalling SDR 772 million
received from 7 countries, viz., Turkey, Algeria, Brazil, Indonesia,
Uruguay, Ukraine and Moldova.

1. BIBLIOGRAPHY

➢ www.rbi.org.in
➢ www.investopedia.com
➢ www.scribd.com
➢ www.wikipedia.com
➢ www.infodriveindia.com
➢ www.indiamart.com

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