Is the Economic Survey overestimating reserves adequacy?

There is some concern in the finance ministry about the adequacy of foreign exchange reserves in case there is an unanticipated and large withdrawal of dollars.

It’s interesting that this year’s Economic Survey, presented yesterday, has devoted a few paragraphs to the sustainability of foreign exchange reserves even though no one else is talking about it just yet.

This suggests that there is some concern in the finance ministry about the adequacy of reserves in case there is an unanticipated and large withdrawal of dollars.

I remember the government catch phrase then: there is cause for concern but not for panic. This year’s Survey reminds me of that.

A report in this newspaper says, “India’s salient external sector sustainability indicators are strong and much improved as compared to what they were during the global financial crisis or taper episode of 2013.”

The report quotes the Survey as saying “the import cover and foreign exchange reserves are more than double now. The combination of high foreign exchange reserves, sustained foreign direct investment, and rising export earnings will provide a good buffer against any liquidity tapering/monetary policy normalisation in 2022-23”.

After citing reasons for this confidence, the Survey says there has been a large inflow of funds and that vulnerability indicators like ‘reserves to total external debt, reserves to short-term debt and reserve cover of imports’ are all looking good. The net international investment position (IIP) to GDP ratio has also declined to (-) 11.3 percent, as against (-) 18.2 percent in 2014, as has the external debt to GDP ratio.

The Survey also talks about the current account surplus of 0.9 percent last year during April-June Q1 as also 2021-22. The ratio in 2013 was 4.8 percent of GDP in 2012-13 and 4.3 per cent in 2011-12.

There is a sense of déjà vu in all this, at least for me. Very similar reassurances had been given in the Surveys of 2014 and 1990. While India escaped a major balance of payments crisis in 2014 — even though it had become a fully paid up member of the Fragile Five —it was very close to it. But it wasn’t so lucky in 1990.

The reason: these vulnerabilities are not determined by what you have in the kitty but what can go wrong with things because of completely unforeseen events whose impact is underestimated.

This is what had happened in 1990 and this could have happened in 2014 when the sudden vote for a stable central government made all the difference.

In 1990, the main problem lay not on the economic side, which could have been managed if the political mandate had been forthcoming. It lay, instead, in the highly unstable political situation. Only a few internal and external jolts were needed to unravel the whole thing.

These came in the form of, first, the announcement of the Rath Yatra by the BJP in July 1990 and, then, Prime Minister VP Singh’s response: the implementation of the Mandal Commission’s recommendations on reservations in August.

And as if this was not enough Saddam Hussein invaded Kuwait and sent oil prices soaring.

Even more importantly, even though its owners were different, the proportion of quickly reversible foreign capital inflows was very high then, just as it is now.

Commodity prices were also high and climbing, just as they are now. Inflation, too, was high; and equally significantly, the global economy was going through an extremely uncertain phase, caused by the economic policies of the US.

If the results of the UP forthcoming election are adverse to the BJP, it will cause a level of political uncertainty that we could do without. And if China goes on a rampage somewhere, that too could cause serious problems.

In sum, looking at reserves adequacy at a point in time, or even over a couple of years, without reference to what could upset the apple cart is like looking at a 100 birds sitting on the branch of a tree, ignoring the things that could make them suddenly fly off.