Managing India's Foreign Exchange Reserve: A preliminary exploration of issues and options

Since mid-nineties, India’s foreign exchange reserves (FER) – both nominal and real adjusted for price level – started growing considerably and reached a new peak of US$ 251985 million in 2008-09. The fact that such unprecedented accumulation of FER build-up has materialized despite India's balance of payment on its current account being mostly negative, has raised debates on the major potential challenges for Indian Sovereign Wealth Fund (SWF), in case they come to existence. Using the two measures of reserve adequacy - the ratio of reserves to short-term external debt and ratio of reserves to broad money – the study indicates “too much” of reserves build-up for the Indian economy particularly since 2002, suggesting thereby that India has substantial amount of surplus reserves. Given the fact that India’s current account balance is worsening for the last couple of years, it could be noted that the increase in India’s FER has been caused by speculative capital inflows on the capital account. In other words, the reserve is very much exposed to potential sudden outflows by foreign investors and any decision should be taken keeping this perspective into account