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 Development is the Key
 
Dealing with surpluses
Business Standard, India Wednesday, November 03, 2010


The combined surplus cost of forex, money and commodity markets can be interpreted as the cost of stability and security. The era of socialistic economics typified a country with perennial shortages where success was measured by having enough to go by. Shortages have given way to surpluses quite often. The question that has arisen is whether or not we have learnt to live with surpluses and, as a corollary, the cost attached to those surpluses, writes Madan Sabnavis in Business Standard.

The era of socialistic economics typified a country with perennial shortages where success was measured by having enough to go by. Things have changed after reforms were introduced, which evolved in an era of globalisation when India has turned around to become a dominant force in the global economic space. Shortages have given way to surpluses quite often. The question that has arisen is whether or not we have learnt to live with surpluses and, as a corollary, the cost attached to those surpluses.
 
...

The forex market has seen our reserves grow substantially over the years and was around $255 billion by March 2010. The trade deficit is no longer a critical factor since software receipts, foreign institutional investors (FII) and foreign direct investment (FDI) inflows have more than made up for this deficit. While there has been debate over what should be done with these forex reserves, the Reserve Bank of India (RBI) has, as a prudent measure, parked them essentially in safe havens of Federal bonds, other central banks, the Bank of International Settlements and so on. This ensures that the money is safe.

...

If a commercial rate were applied to these surpluses, the cost would be even higher, though there would be a risk attached. Forex reserves also run the risk of losing value, which will happen every time the rupee appreciates considering that most of our reserves are in dollar assets. Hence, the RBI has to protect the rupee from appreciating in the interests of exporters as well as forex reserves.

Money market intervention is necessary for all central banks to control interest rates. Ideally, there should be intervention only when there is a high level of volatility in the call market. There were times when the rates would come close to zero or cross 100 per cent when there were acute shortages. The RBI would then try and draw out liquidity or supply it through the rediscounting window to stabilise rates. However, over time the RBI has fixed the upper and lower bands of the repo and reverse repo rates. While there are two views on this issue, the RBI does bear a cost when there are surpluses in the system.

...

The third market relates to commodities, where the government comes into the picture in the process of procuring foodgrain and then stocking it or distributing it. Since the procurement scheme is an open-ended one, the Food Corporation of India perforce has to take in what is offered. This being the case, it has stocked 58 million tonne as on July 2010 against a buffer norm of 32 million tonne, stored, which means there is a surplus of 12 million tonne of rice and 14 million tonne of wheat.

...

If all these three costs are summed, it would work out to between Rs 23,000 crore and Rs 25,000 crore a year, which is significant in a framework that is committed to the market mechanism. This can be interpreted as the cost of security or stability that is being borne by different arms of the government. There is ideologically nothing wrong or right about this expenditure, though it may be useful to revisit these policies and costs.

This article was published in the Business Standard on Wednesday, November 03, 2010. Please read the original article here.
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