Reserves to GDP ratio stands at 14.5%

RBI REPORT ON CURRENCY & FINANCE: 2002-03

Among emerging markets, India's ratio of foreign exchange reserves to gross domestic product stands at 14.5 per cent as against a high of 94.3 per cent for Singapore and a low of 7.9 per cent for Mexico.

This is in the backdrop of the country's reserves having gone up to $103.1 billion "" the sixth largest pile-up in the world.

In fact, the strength of forex reserves led the International Monetary Fund to designate India as a creditor country under its Financial Transaction Plan.

However, there is much debate over how much should be the ideal level of reserves, the RBI report says.

While some experts prefer a high level to shrug off a variety of risk in the developing economies, others feel that accumulation of high level of reserves creates a moral hazard as it reflects a country's attempt to insure against weak domestic fundamentals.

To this effect, reserves to short-term debt has emerged as a benchmark for determining the adequacy of reserves.

In addition to this, other potential indicators to indicate external vulnerability have been also developed such as reserves to either monetary base or some measure of money stock and reserves over GDP.

It has also been mentioned that the level of reserves is a fallout of the exchange rate policy being pursued. In this respect, an analysis of the complexities and challenges faced by emerging markets revealed that the choice of a particular exchange rate regime alone cannot meet all the requirements, the report said.

Quoting from RBI deputy governor Rakesh Mohan's speech, the report said the advocacy of corner solutions "" such as a fixed peg or a freely floating exchange rate "" is on a decline.

The weight of experience seems to be clearly in favour of intermediate regimes with country-specific features, no targets for the level of the exchange rate, and exchange rate interventions to fight market turbulence.

The report, while deliberating on reserve maintenance, has clarified that arbitrage opportunity is unlikely to be the prime motive for influencing investments and thus reserves.

This is because the minimum period of deposits by non-resident Indians in rupees is now one year and the interest rate on such deposits is subject to ceiling rate of 25 basis points over Libor.

Outside of the NRI deposits, investments by foreign institutional investors in debt funds is subject to a cap of $1 billion in aggregate.

And interest rates and yields on illiquid securities are highly variable abroad as well as in India and the differential between the two rates can change sharply within short time depending on market expectations.

Taking into account the forward premiums on dollars and the yield fluctuations, there is likely to be little incentive to send large amounts of capital to India merely to take advantage of interest rate differential, the report summarises.