India: Management of Foreign Exchange

[This is related to a JNUEE essay question of 2005.]
[Reference: Charan Singh 2005]

India followed a restrictive external sector policy until 1991, mainly designed to conserve limited FER for essential imports (petroleum goods and food grains), restrict capital mobility, and discourage entry of multinationals. The external sector strategy since 1991, though gradual in approach, has shifted from import substitution to export promotion, with sufficiency of FER as an important element. As a result of measures initiated to liberalize capital inflows, India’s FER (mainly foreign currency assets) have increased from US$6 billion at end-March 1991 to US$140 billion at end-March 2005. India ranks fifth in the world in holdings of FER in 2004.
The current account was opened in August 1994, and the capital account is cautiously, though gradually, being liberalized.

1) To preserve the long term value of reserves in terms of purchasing power over goods and services.
2) To minimise risk and volatility in returns.(ensuring safety and liquidity)
3) To provide confidence to domestic and foreign investors in markets.

What Are the Sources of Rising Foreign Exchange Reserves?
The main sources of rising FER in India are inflows of foreign investment (more portfolio than direct) and banking capital, including deposits by non-resident Indians. Foreign portfolio investment is considered less stable than foreign direct investment but here in India most of our FER is made up of foreign portfolio investment.

How Are the Foreign Exchange Reserves Managed in India?
The Reserve Bank of India (RBI), in consultation with the Government of India, currently manages FER. The essential framework for investment is conservative and is provided by the RBI Act, 1934, which requires that investments be made in foreign government securities (with maturity not exceeding 10 years), and that deposits be placed with other central banks, international commercial banks, and the Bank for International Settlement following a multicurrency and multi-market approach. The direct financial return on holdings of foreign currency assets is low, given the low interest rates prevailing in the international markets.

Singapore model

Singapore has earned a return of 9.5 per cent a year, in US dollar terms compared to a mere 3.1 per cent India has earned.

More Details
For more details visit The Hindu Business line: Following the Singapore model.
For those interested in knowing more about Indian FER and for those preparing for JNU entrance exam, go through this paper by Charan Singh.

Posted@ Undergraduate Economics

6 thoughts on “India: Management of Foreign Exchange”

  1. i want to know about the institutes in India which impart foreign exchange degree through correspondence course. it will be agreat priviledge if u kindly give me the details of the institute.thank you.

  2. I want to know that which are the institutes in India that offer correspondence courses in wealth management in India itself. i will be thankful if you can give me the details about my queries,thank you.

  3. I wanted to know how RBI Manage foreign exchange reserves and are they good in it also I wanted to know what could be implication for capital account convertibility program if they open it more.

  4. Dharmesh,

    The RBI’s mechanism of management is mentioned above. Besides, I cannot comment on whether it is ‘good’ or ‘not’. Rather, the question ought to be: Can they do it better? I believe that that answer is yes.

    CAC program will benefit if they open ‘it’ more. The implications on the Indian economy, will be varied. Some will benefit. Relative poverty will increase. Prices will tend to fluctuate more easily, etc.

  5. Hi respected sir ,

    can you please tell me what is the difference between capital account and current account with some example or issue to clarify..

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