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India’s foreign exchange reserves have gone up by over $160 billion since the beginning of the last fiscal year and are currently at about $640 billion. If the trend continues, India could soon have reserves worth over $700 billion. The country clearly has come a long way from the situation it faced in the early 1990s when it narrowly avoided a default. But now that India has one of the largest foreign exchange reserves, the debate has shifted to what it should do with the pool. It is often suggested that reserves should be used to finance infrastructure needs. But it’s not clear how this can be done. Foreign currency can be used to buy foreign goods and services, or assets. Thus, the use of reserves would mean that India will be importing a lot of equipment and material for building infrastructure. This is unlikely to be the preferred way and will have a variety of macroeconomic implications.
Another option that is often suggested is forming a
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