For a country like India, forex reserves have long been treated as precautionary savings that the government acquires as a “rainy day” fund to tide over any sudden decrease in capital inflows.
In other words, it acts as a buffer against shocks to external wealth.
On the other hand, countries like China, the UAE, Norway, Saudi Arabia, Russia, Singapore and many others prefer higher returns to liquidity.
The precautionary savings in such countries manifest in the form of Sovereign wealth fund (SWF), a state owned investment fund that is riskier than traditional forex reserves.
Over the last two decades, India has exhibited robust macroeconomic fundamentals and is one of the most attractive destinations of foreign investment. This has resulted in an unprecedented accumulation of forex reserves. It may be noted here that India’s forex reserves accumulated to a record high of over $600 billion a few weeks back.
This makes us the fifth largest holder of forex reserves after China, Japan, Russia and Switzerland, according to RBI.
Such a high accumulation of reserves has prompted the government to explore an in vestment strategy whereby the accumulated reserves can be better utilised. It is imperative to unleash the catalytic power of government in vestment to offset the shadow of the Covid-19 pandemic on India’s growth story.
The newly announced Pradhan Mantri Gati-shakti National Master Plan for infrastructure and other mega infrastructure projects necessitate a careful appraisal of our financial firepower.
That brings us to the fundamental question:
Does India have “too much” reserve buildup and hence “surplus” reserves for the government to explore an in vestment strategy?
To answer this question, we look at two popular measures of reserve adequacy of a country.
- The first measure of a country’s susceptibility to currency crisis is the ratio of reserves to short term external debt. Also known as Guidotti–Greenspan rule, the critical value of this ratio is one, with a value below one being undesirable.
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The Guidotti–Greenspan rule states that a country’s reserves should equal short-term external debt (one-year or less maturity), implying a ratio of reserves-to-short term debt of 1. The rationale is that countries should have enough reserves to resist a massive withdrawal of short term foreign capital
- The second indicator of reserve adequacy is the ratio of reserves to M3 or broad money. This ratio is especially relevant for countries like India that are a haven for ‘hot money’ investment by large foreign institutional investors and hence are subject to a major risk of capital flight. It is suggested that a critical value of this ratio in the range of 520 per cent is desirable.
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M3 (broad money) is commonly used to measure the money supply. Among other things, this includes currency with public and demand deposits of banks. So, withdrawal of Rs.100,000 in cash does not make any difference to the aggregate money supply.
An analysis of time-series data on Indian economy for past three decades suggests that India comfortably fulfills both these measures.
With the ratio of reserves to short-term external debt exceeding one in all the years since 1991-92 and the ratio of reserves to broad money above 20 per cent for all the years since 200203, there is ample evidence of “too much” of reserves buildup for the Indian economy.
However, the following precautions may be noted.
First, creation of SWFs tends to be common practice among major fuel and commodity exporting countries. SWF creator countries, which are not intensive fuel exporters, otherwise possess large current account surpluses (namely, China). India is neither an oil exporting country, nor has current account surplus.
Secondly, India’s growing fiscal deficit has the potential to create adverse trade imbalances, popularly known as ‘twin deficit’, thereby prompting the government to adopt a cautious approach.
In addition, RBI has advised a pragmatic assessment of reserve adequacy in view of existing level of forex reserves being projected to cover less than 15 months of imports (while countries higher than us in forex reserves position boasting anywhere between 16 and 39 months of import cover).
It has been held — rightly so — that accumulated reserves are not ‘owned’, they are liabilities. Essentially, forex reserves are built up from in vestment flows and have long been used as a cushion to avert crises that cause precipitate outflows of foreign exchange.
Nonetheless, just as a bank lends out money from its liabilities (read deposits) while keeping aside a part that is deemed sufficient to take care of exigencies, forex reserves may be suitably subject to this calculus.
While it is apparent that RBI is already diversifying its forex investments in a basket of currencies to earn higher returns, some part of our reserves can be committed for longer term investments.
As India turns 75, it is time to assess whether our forex reserves can help further our geo-economic and strategic priorities while not disregarding the above expressed concerns. A wider consultation on the subject is the need of the hour.
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Petrol in India is cheaper than in countries like Hong Kong, Germany and the UK but costlier than in China, Brazil, Japan, the US, Russia, Pakistan and Sri Lanka, a Bank of Baroda Economics Research report showed.
Rising fuel prices in India have led to considerable debate on which government, state or central, should be lowering their taxes to keep prices under control.
The rise in fuel prices is mainly due to the global price of crude oil (raw material for making petrol and diesel) going up. Further, a stronger dollar has added to the cost of crude oil.
Amongst comparable countries (per capita wise), prices in India are higher than those in Vietnam, Kenya, Ukraine, Bangladesh, Nepal, Pakistan, Sri Lanka, and Venezuela. Countries that are major oil producers have much lower prices.
In the report, the Philippines has a comparable petrol price but has a per capita income higher than India by over 50 per cent.
Countries which have a lower per capita income like Kenya, Bangladesh, Nepal, Pakistan, and Venezuela have much lower prices of petrol and hence are impacted less than India.
“Therefore there is still a strong case for the government to consider lowering the taxes on fuel to protect the interest of the people,” the report argued.
India is the world’s third-biggest oil consuming and importing nation. It imports 85 per cent of its oil needs and so prices retail fuel at import parity rates.
With the global surge in energy prices, the cost of producing petrol, diesel and other petroleum products also went up for oil companies in India.
They raised petrol and diesel prices by Rs 10 a litre in just over a fortnight beginning March 22 but hit a pause button soon after as the move faced criticism and the opposition parties asked the government to cut taxes instead.
India imports most of its oil from a group of countries called the ‘OPEC +’ (i.e, Iran, Iraq, Saudi Arabia, Venezuela, Kuwait, United Arab Emirates, Russia, etc), which produces 40% of the world’s crude oil.
As they have the power to dictate fuel supply and prices, their decision of limiting the global supply reduces supply in India, thus raising prices
The government charges about 167% tax (excise) on petrol and 129% on diesel as compared to US (20%), UK (62%), Italy and Germany (65%).
The abominable excise duty is 2/3rd of the cost, and the base price, dealer commission and freight form the rest.
Here is an approximate break-up (in Rs):
a)Base Price | 39 |
b)Freight | 0.34 |
c) Price Charged to Dealers = (a+b) | 39.34 |
d) Excise Duty | 40.17 |
e) Dealer Commission | 4.68 |
f) VAT | 25.35 |
g) Retail Selling Price | 109.54 |
Looked closely, much of the cost of petrol and diesel is due to higher tax rate by govt, specifically excise duty.
So the question is why government is not reducing the prices ?
India, being a developing country, it does require gigantic amount of funding for its infrastructure projects as well as welfare schemes.
However, we as a society is yet to be tax-compliant. Many people evade the direct tax and that’s the reason why govt’s hands are tied. Govt. needs the money to fund various programs and at the same time it is not generating enough revenue from direct taxes.
That’s the reason why, govt is bumping up its revenue through higher indirect taxes such as GST or excise duty as in the case of petrol and diesel.
Direct taxes are progressive as it taxes according to an individuals’ income however indirect tax such as excise duty or GST are regressive in the sense that the poorest of the poor and richest of the rich have to pay the same amount.
Does not matter, if you are an auto-driver or owner of a Mercedes, end of the day both pay the same price for petrol/diesel-that’s why it is regressive in nature.
But unlike direct tax where tax evasion is rampant, indirect tax can not be evaded due to their very nature and as long as huge no of Indians keep evading direct taxes, indirect tax such as excise duty will be difficult for the govt to reduce, because it may reduce the revenue and hamper may programs of the govt.