Tags:
Journalism of Courage
Remarks by Alan Greenspan, chairman of the US Federal Reserve Bank, that given the size of the US trade deficit, foreign demand for US government securities is likely to wane at some point, has led to high volatility in the Euro-dollar market. In other words he admitted that the US trade account deficit, which is likely to touch US 600 billion this year, needs to be corrected, and that for this adjustment to take place, the dollar may be expected to weaken. The US debt-to-export ratio is estimated to be 280 per cent, close to that of troubled Latin American economies like Brazil and Argentina. Despite the large and growing stock of external debt, the US has been able to finance its current account deficit due to the purchase of US treasury bills by Asian economies like India, China, Korea, Singapore and Taiwan. A weakening dollar would mean that the value of the foreign currency assets of these countries, which largely consist of US government treasury bills, would fall. It may thus be expected that they would incrementally move towards Euro- or Yen-denominated assets. This would reduce the demand for the US dollar and cause its weakening.
If the dollar declines relative to the euro, it would mean even more pressure on the rupee to appreciate in terms of the dollar. If the RBI tries to fight off this pressure by buying dollars, as it has in the past, it could end up with even bigger foreign exchange reserves than it has, at a time when there is consensus that the level of reserves, at US 123 billion is already too high. The proposal by Montek Ahluwalia, deputy chairman, Planning Commission, that foreign exchange reserves should be used for infrastructure lending is based on the belief that India8217;s reserves are adequate and, if anything, must be reduced.
