The Telegraph
Since 1st March, 1999
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- Foreign exchange reserves are not really India's to spend

If a country's prosperity is defined in terms of the foreign exchange assets it holds, India had never had it so good. Foreign exchange holdings at this moment exceed $ 130 billion. Compare this to the horrendously low $1 billion held at the mid-point of 1991. Cataclysmic changes were then introduced in India's economic policies to cope with the situation. That kind of nightmare is seemingly over for ever and it is henceforth jingle bell, jingle bell, jingle all the way.

There is ample reason to argue that the inflow of foreign exchange is not going to stop in the immediate future. International speculators are currently in love with India. They are allowed to bring in funds and take them out whenever they like. A slice of these funds they park with Indian banks and earn a comfortable rate of interest, a rate substantially higher than what is offered, for instance, in the United States of America. Most of such short-term funds are, however, deployed in the country's stock exchanges. No capital gains taxes are to be paid; foreign institutional investors therefore make a beeline for the bourses in Mumbai, Chennai, Hyderabad, Delhi, Kanpur and Calcutta. As much as 40 per cent of the transactions in the share markets are attributable to foreign speculators; with this much of clout, they dictate the proceedings in the bourses. It is to the interest of the foreign institutional investors that share prices keep soaring, to dizzy and dizzier heights. Once they decide the time has arrived for profit gathering, they sell the shares and take their earnings for remittance abroad.

The story spreads across the continents; India's stock exchanges provide such rich gravy. More and more international speculators crowd into our share markets, and the country's foreign exchange holdings continue to scale more and more gigantic heights. Those presiding over the country's affairs can relax: no memory of the pre-1991 days should henceforth disturb their psyche.

Perspectives nonetheless differ from party to party. According to many monetary and foreign trade specialists, foreign exchange reserves covering a country's imports for roughly six months is enough to take care of contingencies if, for some reason or other, short-term payments difficulties arise. To hold further foreign exchange assets is, they feel, a luxury the country can do without. The deputy chairman of the Planning Commission appears to endorse this view. A reserve stock of $40 to $50 billion, in his judgment, should be adequate for the management of balance of payments; the rest of our foreign exchange holdings are almost idle hoards.

In the view of the deputy chairman, a major part of our surplus foreign exchange holdings should be used up for developing the country's economic infrastructure. The country lacks state-of-the-art facilities such as roads and bridges and harbours and airports of international standard. To attract foreigners into India's industry and agriculture, we must, the deputy chairman is convinced, transform the state of our infrastructure, both qualitatively and quantitatively. Perhaps, he has in mind airports like JFK in New York and O'Hare in Chicago and roadways like the German autobahn and the New Jersey Turnpike. Were we so bold as to deploy our excess foreign exchange to develop facilities similar to these, there would be no stopping the country's rapid economic development.

There is a problem though. Our foreign exchange holdings ' the bulk of them ' do not actually belong to us. We have not earned them through, for example, exporting our merchandise and services. These holdings are with us because foreign parties who own them have temporarily placed them with us. They are a part of the global footloose capital flows which have entered India in quest of high returns either from stock market speculation or from investment in bank deposits. Sooner or later, the owners of such capital might want their money to be repatriated overseas and in foreign exchange. In case we use up these holdings to develop replicas of the JFK airport and the New Jersey Turnpike, we will have no foreign exchange left to foot the bill of repatriation.

The deputy chairman will therefore have to be disappointed; the governor of the Reserve Bank of India has told him as much. But the phenomenon of surplus foreign exchange holdings will persist. They are a nuisance, but not for the reason the deputy chairman thinks. The foreign institutional investors who walk in freely into our stock exchanges and speculate with their free-wheeling funds are actually a hindrance to the country's economic growth. In their search for quick profits, they often heat up the share markets. Because of their manipulations, share prices rise and rise. The ordinary Indian householder is enchanted; profits can be earned and income can be doubled, tripled and quadrupled so easily, by merely placing money in the share markets. The lure is irresistible: those with even the meagrest means rush to the stock exchanges and buy, buy, buy.

Thereby is enacted a tragedy. For a poor country, which India remains, the major task to ensure development should be the foregathering of savings, which can be turned over for investment, by those who can afford to save. However, given the false climate we have been trapped into, honest citizens do not think any more in terms of savings; they, instead, scrape together whatever resources they can put together and plunge into share speculation. The government follows the lead and comes to believe that the nation's economic health is co-terminous with the wellbeing of the bourses.

The deputy chairman of the Planning Commission is right. We have to curb the unhealthy bulge in our foreign exchange reserves. But, to do so, we must see to it that the group of master speculators ' those who goad others to speculate ' are shunted out of our precincts. This can be done through two easy means. First, we re-impose controls and restrictions on the inflow of foreign funds so that foreign money, which is not invested in production activities but is devoted exclusively to speculation, does not get easy entry into the country and its exit is made equally difficult. Second, we impose a heavy tax ' not a token one ' on share market transactions besides bringing back a heavy dose of capital gains taxation.

These are obvious solutions to the riddle of surplus foreign exchange funds. Easy solutions do not though always satisfy specific interest groups. The lobby for running down foreign exchange reserves to import material, equipment and expertise to build beautiful and expansive shopping plazas, tourist extravaganzas, dazzling expressways and dizzy skyscrapers will therefore continue to be around. The argument that the foreign exchange reserves do not really belong to us to spend is unlikely to cut any ice with them. Who knows, perhaps, there is more than meets the eye in this demand to eat away the exchange reserves. Once the reserves disappear following the government's yielding to pressure to deploy them for developing the nation's economic infrastructure, there is bound to be another acute foreign exchange crisis, forcing the country to sign a further deed of transfer of its economic sovereignty to foreigners.

And will it be impolite to point out that to spark faster growth in the country, we need infrastructure, but infrastructure that is integrally linked to rural reconstruction ' irrigation channels, drainage, land reclamations, rural roads, primary schools, village health centres ' and not exhibits of zilch and glitter. The Planning Commission bigwigs will again be disappointed: rural reconstruction calls for very little spending of foreign exchange.

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