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The FOREX Reserve Conundrum: It’s Dr.Rajan vs History.

The FOREX Reserve Conundrum: It’s Dr.Rajan vs History.

By Angad V

In a recent conference call with various economic researchers and analysts, Dr. Raghuram Rajan, Governor of the RBI, has categorically stated that India can never be completely immune to external shocks unless its FOREX reserves are at least on comparable terms with its geopolitical ally, nemesis, grin-and-bear neighbour – China.

To quote Dr. Rajan, “We have a lot of forex reserves. Right now, it is $300 billion plus. So, the key question is at what point you feel safe. I think, if you focus only on reserves, there is really no point at which you feel safe… 400, 500, 600…any level of reserves, until you get to Chinese level, it is probably not enough.”

This answer was in reply to a question posed to him, asking whether the central bank was comfortable with the level of FOREX reserves as of this moment.   Let’s elucidate the FOREX Reserve scenario a little further, before analysing Dr. Rajan’s comments.


In the bygone era of the Bretton Woods Agreement — countries smartly used their FOREX reserves, via their central banks, to maintain the exchange rate of their respective currencies at relatively constant levels.  Over time, the system gradually evolved, as massive globalization saw a tectonic shift in the role played by a country’s holdings in foreign currency. Since the collapse of the Bretton Woods model, countries today generally use their FOREX reserves to finance their external obligations— such as sovereign and commercial debts, imports, intervening in foreign markets to stabilise volatilities etc.  A healthy FOREX reserve also acts as a confidence booster for potential investors who shall rest assured that said nation is capable of meeting any outstanding payments.  It forms a protective shield, so to speak, protecting a nation from sudden global economic shocks.

Post the 2008-09 global financial crises, economists have observed that developing markets are better protected against the cascading effects of such a crisis, since they hold a significant portion of their wealth in FOREX reserves.  To compare and contrast two scenarios, Brazil and Mexico are as good examples as any.

In September 2008, Brazil had foreign reserves of USD 205.5 billion—equivalent to 12.9 % of its GDP—while Mexico had USD 83.6 billion, or 7 % of its GDP.  Mexico was teetering on the edge, as its parameters were well below the recommended precautionary levels.

Then, on the night of September 14th 2008, in a decision that hardly surprised Wall Street, Lehmann Brothers filed for Chapter 11 bankruptcy.

Brazil’s safe reserve levels gave the BCB sufficient time and room for an effective response. It set up smooth swaps to help bail out Brazilian companies that were struggling to divest dollar-denominated securities.  It also ensured that the Brazilian Real did not spike up against the USD, thus helping exporters to combat tricky financial waters.  Additionally, Brazil had navigated itself into safe territory by bulking up more than half of its current account in commodities, which were doing very well prior to Sept. ’08 – thus generating a healthy surplus in the current account.  The economy also saw a huge growth in FDIs, given its high interest rates and a bullish economy.  In the period of 2004-08, Brazil had increased its FX reserves by more 200%.

In sharp contrast, Banxico (Mexico’s central bank), was simply not well prepared enough to counter the sharp upward surge of the Peso vis-à-vis the USD.  Less than two-tenths of Mexico’s current account comprised commodities – an area where it faced stiff competition from China, simply because the US seemed to prefer Chinese to Mexican. In the same period where Brazil tripled its FX reserves, Mexico’s barely increased by 40%.  Furthermore, its current account continued to wallow in the red.

All said and done, Brazil emerged from its temporary recession in the second quarter of 2009, years before Mexico could resurface.  The staggering difference in their FX reserves proves that prior planning on the FOREX front is of prime importance in the wake of a dire collapse.


Back to the present day, it is interesting to note that Dr. Rajan’s comments come when he is the top central banker in India, where the RBI has stringently avoided setting itself any FX target levels.

India’s present reserve is dwarfed so comprehensively by China –at USD 3.66 Trillion, it has a reserve about 3 times the size of the next highest economy on the list (Japan) – that mentioning them in the same breath is nothing short of fantastic.

While Prof. Rajan’s term has seen an increase of USD 25 Billion, since August 31st 2013, he stresses that there is a greater need to focus on developing policy that improves investor confidence. “We, at the RBI, have been trying to provide this confidence and I think this is a far better way [as opposed to building up a FX reserve]”.

Dr. Rajan further reiterated that any involvement of the RBI in the FX market is only with the aim of rectifying any perceived instability, beyond acceptable risk.

“Our intervention in exchange market has historically been to reduce exchange rate volatility… [Sic] not just the volatility today but also the anticipated volatility if the exchange rate becomes unduly strong because of extreme inflows or unduly weak because of extreme outflows… [Sic] to intervene to prevent that kind of volatility, we have plenty of reserves,” he said.

Dr. Rajan no doubt, has a clear vision for the future of India’s economy.  This is one instance however, where recent historical precedents spin a tale in clear contrast to his policy implementation.


  Angad Vijaya Raghavan is currently pursuing his undergraduate studies at BITS Pilani, Pilani Campus.  While he remains quite proud of the couple of degrees he’ll mostly receive in a year or so, his real interests lie in the murky world of financial markets and analysis.  His long-term plans include philanthropy and the like, but realises that any more procrastination might lead to him being the recipient – rather than the source – of society’s generosity chain.

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