Forex reserves: A problem of plenty

How to utilise the forex reserves. 

The government could channel part of the huge inflows into the following:
 
» Fund infrastructure projects

» Move towards full capital account convertibility

» Lower trade barriers

» Make strategic investments abroad

» Recapitalise weak banks
 
Foreign exchange reserves with the Reserve Bank of India (RBI) have swelled to over $200 billion (Rs 8.2 lakh crore). This is leading to a higher supply of money and is stoking inflation.

So what's the solution? There is a proposal to borrow $5 billion (Rs 20,500 crore) from the country's reserves to fund infrastructure projects. Says T.K. Bhaumik, Chief Economist, Reliance Industries: "The government should earmark about 10 per cent of the forex inflows for infrastructure development." But, cautions Subir Gokarn, Chief Economist, CRISIL: "Foreign exchange reserves cannot be a panacea for our infrastructure problems as the commercial viability of many sectors is suspect."

Economists feel that the government should use its massive reserves to move swiftly towards full capital account convertibility. Says Gokarn: "Earlier, there were concerns that the banking system would not be able to cope with a sharp outflow of funds. But now, there is a more compelling argument to free up the whole gamut of transactions." Adds Siddhartha Roy, Economic Adviser, Tata Group: "If we become more market-oriented, there won't be an unnecessary accumulation of reserves."

Some economists also feel that India should follow China's example. China, which has foreign exchange reserves of $1.2 trillion (Rs 49.2 lakh crore), has recently firmed up plans to invest $3 billion (Rs 12,300 crore) in us private equity firm Blackstone. China has also used its forex reserves to recapitalise banks by replenishing their equity capital. Says Bhaumik: "The RBI could consider such measures for weak banks on a case-to-case basis."

But RBI and policy planners are still intent on falling back on age-old methods from another era-and choking investments and demand in the process.