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Guard against swings in portfolio flows: RBI -- Building forex reserves as cushion advocated

Our Bureau

MUMBAI, Aug. 28

THE Reserve Bank of India, in its Annual Report 1999-2000, has advocated the need for building up foreign exchange reserves to protect the economy from volatility in portfolio flows.

``Indian financial markets have become increasingly sensitive to asset price movements abroad. Portfolio flows are sensitive to these movements and, therefore, it is necessary to build cushions to guard against sudden movement of portfolio capital in res ponse to international asset prices. One way to protect the economy from the effect of volatility in portfolio flows is to build international reserves,'' the Annual Report states.

The RBI statement is significant in the light of the fact that the rupee has lost about five per cent against the dollar since April 1, 2000. One of the main reasons attributed by the forex dealers to the fall was the withdrawal of funds by foreign insti tutional investors. It is believed that the Centre is now looking at raising $5 billions on the lines of Resurgent India Bonds (RIBs) to further bolster the forex reserves. The country's forex reserves currently stand at $ 35.63 billions.

The report mentions that the policy for forex reserve management is built upon a host of identifiable factors and other contingencies. ``Such factors include, inter alia, the size of the current account deficit and the short-term liabilities (including c urrent repayment obligations on long term loans), the possible variability in portfolio investment and other types of capital flows, the unanticipated pressures on the balance of payments arising out of external shocks and movements in the repatriable fo reign currency deposits of non-resident Indians,'' the report said.

GDP growth at 6.5 pc this fiscal: The RBI has forecast the real GDP growth to be about 6.5 per cent during 2000-01. ``If the industrial recovery is ensured and assuming continued buoyancy in the services sector, real GDP growth during 2000-01 could be ab out 6.5 per cent. Such an order of growth should have favourable effects on inflation expectations particularly if the fiscal deficit and monetary expansion are kept at reasonable levels,'' the report states.

Fiscal imbalance: The central bank has also expressed concern at the high level of fiscal imbalance of both the central and the state governments which touched a high of 9.9 per cent (combined gross fiscal deficit) of GDP in 1999-2000. ``While the high l evel of government sector deficit is attributable to some unavoidable expenditure commitments as well as unanticipated shocks, any further erosion of the fiscal position could turn out to be unsustainable, since the financial saving rate of the household sector is only moderately higher than the ratio of overall fiscal deficit to GDP,'' the report states.As per the report, the high level of debt fuels expectations about the uncertainties of future budgetary policies and adds higher risk premium, thereby leading to volatility in the financial markets and constraining downward movement in long-term interest rates. ``While the debt management operations during 1999-2000 attempted to extend the maturity profile without having adverse effects on interest co sts, the high overhang of debt acts as a severe constraint for continuance of such a policy stance in the coming years,'' the report states.

The RBI has also talked about the need for the disinvestment process to take into account the prevailing or the likely capital market conditions and investor preferences. ``It would be useful to build different scenarios assuming different degrees of suc cess of the disinvestment process and propose corrective strategies under each scenario for realising the determined final fiscal outcome.''

The central bank has said it is vital that limits are placed on the quantum and value of guarantees that could be given by State governments. The RBI has also warned that the NPA levels in the banking sector still remains unduly high and ``any delay in t he resolution of the NPA problem could act as a drag on the reforms process itself''.