Why Is The Current Forex Reserve Of India So High
Around two decades back India had such a bad balance of payments that the country had to think about mortgaging its gold reserves to the Bank of England in order to procure foreign exchange required to run the country. Current forex reserve of India is above $260 billion making it fifth highest foreign exchange holder in the world. This article tries to analyze the reason that have played a crucial role in this enormous change.
Most of us are aware of the fact that India had a closed economic model until the decade of 1990s. It is only in the last two decades, that the country has started to open up its market for foreign investments. The Indian rupee was made convertible at the current account in 1994. The capital account is also witnessing an ongoing process of liberalization.
There are four factors which are considered crucial for a growing economy and the amount of foreign exchange reserves that the country requires. The first is the flexibility levels of the exchange rate of the country, the second and third are the vulnerability to capital accounts and current accounts and the fourth is the cost of opportunity. In case of some developing countries like India, there are some additional factors which come into play.
These include the high level of financial integration with the worldwide markets which leads to swift movement of the capital from one location to the other. Then there is the FER which is a kind of insurance in case the things start to get out of hands. The other reason behind the fast increasing forex reserves of the country is the increasing liquidity of the global economy. The reason behind the increasing levels of liquidity can be traced to the financial policies in developed countries. The increasing levels of foreign investment is the most important source which contributed to the current levels of foreign exchange in India. Both direct and portfolio investment are considered to be contributors in this regard. Similarly the constant attempts of the government to woo non resident Indians have also started to bear fruit. The deposits of NRIs went as high as $12 billion in 2004 Â- 2005. Similarly the computer and services sector has also contributed $17 billion The money sent by the Indians working abroad, especially in US and western Europe also increased from $8 billion in 1995 Â- 1996 to $21 billion in 2004-2005. This means an increase of more than 100% in just about 10 years. As told earlier, the current forex reserve of India stands at more than $260 billion. If the current rate of increase in forex reserves is sustained for some time, the forex reserve of India should easily surpass those of Taiwan and secure the fourth position for India.
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