Archive for July 17th, 2015

Build up of forex reserves is actually dollar colonisation

July 17, 2015

It is amazing to note how history is quickly forgotten. Leave history, even current times are ignored just to fit one’s agenda. There is a huge belief that it is high forex reserves which are the safeguard for Indian economy. The same reserve building was criticised greatly pre-2008 period as RBI should only do inflation management and not intervene in forex markets, build up of forex reserves is inflationary, forex reserves distort economy as one issues MSS bills and so on. Even currently, China has the highest forex reserves in kitty and all via its current account surplus (unlike India’s forex reserves which are mainly via short term capital flows) but is unable to keep global threats away. And then post 2008-crisis, Korea could not keep off speculatiion fears away despite pretty high forex reserves as well.

In nut shell, India is safer not because of forex reserves but just because we have kept ourselves relatively closed to world economy. And then compared to world, our macros are not as bad (it is always a relative game). However, our policymakers and media prefer to sing their own tunes.

Infact, one should actually be questioning all this forex intervention business as India had opted for inflation targeting. Earlier, the view was we need to target multiple things as in an emerging economy we cannot just stand by and let certain things like exchange rate go awry. In IT, the first thing central bank does is give up exchange rate management. The forex assets begin to be piled up at banking level and not at central banks. Central banks can instead sign up swap lines with advanced countries in case there is a shock. A swap line ends up being a much cheaper option as well.

C Shivumar has a piece on how all this forex reserve build up is not really chest thumping. It is actually the opposite – it exposes you to dollar policy:

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