Note of confidence

In recent weeks the government and the RBI have addressed the issue of rupee liquidity with speed. Reports that the government is now looking towards solving the issue of dollar liquidity are welcome. Opening stand-by facilities for dollars and euros will enable the RBI to get additional dollars as and when required. This will provide additional comfort to India.

Why is opening currency swap lines for foreign currency useful even though India has 250 billion of reserves? To understand the necessity for this it is important to take into account all possible dollar needs in the coming one to two years. India has about 44 billion of short-term debt. This is mainly trade credit with maturity of up to 180 days. In addition, another 40 billion is expected to mature within the next one year. Until last year such outflows would have been met by dollar inflows on account of FIIs, FDI and loans. These have largely dried up. In addition, the current account may see a deficit if exports go down sharply while imports do not fall in proportion, especially oil imports. This means that to fund the current account and short-term debt obligations India will see a sharply falling rupee. If the RBI tries to defend the rupee, reserves could fall by another 100 billion. Looking forward, there are dollar liabilities of about another 20 billion each in the next two years and another 100 billion beyond the three-year horizon. This adds up to another 140 billion. This means total dollar liabilities which have to be met in the coming years are nearly 240 billion. In addition are the net import requirements for which there may be no capital inflows to finance them.

Reserves have already fallen rapidly by more than 60 billion and another 100 billion can result in the expectation that the RBI cannot keep up its defence of the rupee. Mounting expectations of depreciation could then lead to large capital flight by Indians. The importance of the dollar swap facility is that even if it is never used, as long as the market believes the RBI has access to it, it may prevent a speculative attack on the rupee. In general, whatever the level of foreign currency reserves of a country, it is always subject to the risk of a speculative attack. Therefore, the confidence that we have enough reserves and therefore do not need additional stand-by facilities would be misplaced.