ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Appetite for Official Reserves

There is a strong nexus between the level of reserves, frequency of intervention, and exchange rate variability. Given the current exchange rate arrangements, there is a mandate to accumulate reserves in line with other developments such as import growth, growth in short-term external debt, and so on. The Reserve Bank of India seems to have no option, especially in times of capital flight, than to allow the exchange rate to absorb market pressure if the volume of reserves held is not adequate. This indicates a limited scope for using other instruments. The objective of accumulating additional reserves seems to override the ambition of exchange rate stability when there is a limit on the capacity to intervene imposed by the reserve shortfall. Therefore, reserves matter in times of crisis.

IMF's Call for Complacence

The International Monetary Fund's World Economic Outlook of April 2016 bodes that emerging market economies, including India, are at risk of sudden capital outflows. The IMF once again makes a case for its conventional, much-discredited tools to manage this risk. To repeat these recommendations, that on many occasions have only worsened crises, is to encourage complacency.

Calm before the Storm?

It is generally believed that India is doing far better than most emerging market economies in these times of global economic turmoil. Emerging markets are facing capital flight, with large-scale outflows, especially since the second half of 2015, with the trend expected to continue in 2016. India has been less affected than others, but is clearly vulnerable due to the large number of Indian firms that are exposed to external borrowings, a weak rupee, a year or more of declining merchandise exports, falling corporate profitability, and stressed corporate balance sheets.
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