Indian foreign reserve currently stands at 345 billion dollars. This is an adequate amount to cover 7 to 8 months of import bills. But the reserve is not earned money but mostly borrowed money. It is important that the reader understands the difference. The foreign institutional investor has a portfolio of Indian stocks whose market capitalization is over 19 trillion rupees which is approximately 300 billion US dollars. These are short-term funds employed by foreigners in our bond and stock market to earn superior return as compared what they would in their home country. This includes an enormous capital gain even though we don’t have their initial figures of investment but it is quite evident atleast more than half of that amount may be earned profits. Until now the foreign investors have found our country attractive and to put their short-term funds to work. When they realise that our market is about to decline or stay flat, they may sell off some of their holdings. They did this in 2008. At that time nearly $ 50 billion was taken out of India and the Indian stock market fell massively from 21,000 to 8,000. There is a high probability that this will happen if and when the US fed starts pushing up its fed funds rate. Janet Yellen the US Fed Chair has been threatening the financial market by saying that the interest rate hike is imminent. Another 200 billion $US is borrowed by us in the form of External Commercial Borrowing (ECB).
India both public and private sectors have a great appetite for foreign loans as our domestic savings rate has fallen off from its highs. Interest wise, the cost of funds in the US dollar is way below the Indian cost of funds. However there is a big risk, if unhedged, the effective cost of borrowings may hit of roof when the rupee starts going down in value against the dollar when the US fed starts pushing up its interest rate.
Last week ICICI bank raised 500 billion US dollars by issuing a 5 year t-note at a yield of 3.125%. The US 5 year t-note was trading at around 1.6%, as this money should be returned at the end of 5 years with interest. Previously also they had issued two notes for 600 million and 200 million dollar respectively. Such borrowings will add up to our total external commercial borrowing. All these are possible because of the abundant US dollar availability. These notes were issued through the ICICI Dubai branch.
When we combine all the FII outstanding, ECB loans plus the non-residential Indian funds, our total liability far exceeds our reserves. In the immediate term it may involve only paying the interest rates but in the long run, it can have a serious impact on the value of rupee. In the past we have seen the rupees value falling from Rs.16 to Rs.64 dollar in 20 years. Actually, even now the real effective exchange rate should be well above 70 rupees as against our current exchange rate of 64 rupees.
The best source of funds in future is the equity inflow from overseas. It will be good if India can make serious efforts to attract FDI into manufacturing. This money will be employed in plant and machinery and is unlikely to leave the country. Besides it will create a lot of jobs. Also we should improve our software exports possibly doubling in the next few years. We witnessed in the recent past countries like Argentina, Turkey, Russia faced massive devaluation. Let us hope that we don’t get into the same trap.
Our Prime Minister has visited several countries in the recent one year and appealed to them to invest in the Indian manufacturing. It is a timely effort and let us hope he succeeds. Finally we are very different from China. They have a massive reserve of over 3 trillion dollars mostly earned through exports. It becomes their equity. We in India are still stock with most debts.
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