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Big forex kitty to absorb emerging risks: Reddy

RBI governor YV Reddy has said that with the rise in interest rates the world over, there is a fear among the emerging economies that the level of capital flows may slow down.

TNN|
Sep 20, 2006, 01.59 AM IST
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MUMBAI: RBI governor YV Reddy has said that with the rise in interest rates the world over, there is a fear among the emerging economies that the level of capital flows may slow down.

Thus, the comfort level of forex reserves should not be viewed by the current situation alone, but it should take into account the assessment of the emerging risks.

Also, the global economy has not seen the outcome of a not-so-orderly correction of the current global imbalances. Experts say, in case that happens, it may lead to reversal of capital flows from financial markets.

Dr Reddy’s comments came amid criticism from certain quarters on the cost of forex reserves and its inadequate use. India’s foreign exchange reserves have touched $165bn.

The RBI governor was speaking at a seminar in Singapore on ‘Foreign exchange reserves: New reality and options’. He said, post-Asian crisis it was widely perceived that large reserves were needed by emerging market economies to withstand any crisis and it was a reflection of the lack of confidence in the international financial architecture.

Dr Reddy added that rating agencies, in country-risk analysis, have given high weightage to the level of reserves.

The benefits of holding reserves include maintaining confidence in monetary and exchange rate policies; enhancing the capacity to intervene in foreign exchange markets; limiting external vulnerability so as to absorb shocks during the times of crisis; providing confidence to the markets that external obligations can always be met and reducing volatility in foreign exchange markets.

“It is necessary to recognise that, as in the case of costs, there are difficulties in computing the benefits too,” said Dr Reddy.

He said that in countries like Russia, reserves are built out of current account surplus. In China, Korea and Taiwan, the surplus in both current and capital account leads to accumulation of reserves.

In India, on the other hand, reserves accretion was driven more by capital account surplus and not due to current account surplus, broadly implying that capital inflow was more than what could be normally absorbed in the domestic economy.
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