Indian Economy: News and Discussion

Assassin 2.0

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Sir, I am a master in macro-economics so I will take a dig.

GDP is calculated as = C + G + I + NE
= total private Consumption + total Government expenditure + Investments + Net Exports (exports-imports)

Total trade is not counted, only the net of exports-imports; thats why the trade/gdp ratio of some countries is above 100%

In case of Vietnam,

Annual PPP GDP per year is $ 1 trillion
Annual Nominal GDP is $260 billion (vietnam, like india has an artificially weakened currency, this is how the west likes it)

Vietnam's yearly Exports are $290 billion - Imports are $260 billion
Net Exports are $30 billion

Vietnams GDP is = $90 billion (private consumption) + $70 billion (Government Expenditure) + $70 billion (Investments) + $30 billion (Net Exports) =$260 billion Nominal GDP

For Trade Ratio: 290 exports + 260 imports = 550
Total trade (550) / Nominal GDP (260) = 212%

This basically means, Vietnam is a very trade dependent country and has very little internal economy and thus is not very economically sovereign. Its basically a sweatshop economy, "mini china of 80s" where Korea, Japan, and China send low value goods to do some labor intensive work and add some value and export them back to Korea, Japan, China and USA. This is their entire economic model. In a sense, korea, Japan and China control majority of economic activity in vietnam so its own govt doesnt have much room to go against these countries.

In contrast, India has very low trade as percentage of its GDP, most of our economy is internally fueled, we have a large and productive domestic market so we dont "need" to depend on outsiders. Even if India closed itself to the world like USSR and rest of the world stopped trading with India, our economy will only take a minor 20% hit while Vietnam would crash 60-70%

Same figures for India year 2019

GDP Nominal $3 trillion = $1.5 trillion private Consumption + $1 trillion Investments + $.7 trillion Government Expenditure + ( - $.2 trillion Net Exports)

Exports = $320 billion
Imports = $520 billion so Net Exports are - $200 Billion

Trade ratio for India = 840/3000 = 28%

While for Vietnam its over 200%

Trade ratio isnt a very useful figure by itself without knowing what stage of economic development a country currently is in. It only tells you how globally connected and trade dependent a country is. Large, independent countries like USA and India, China have a low trade ratio.


As you can see, port city-states, small tourist destinations, one trick pony oil sellers and and sweatshop countries have high trade to gdp ratio. (Ignore Eu countries bc most of that trade is intra-Eu)

In a developing country context, moving to a higher trade ratio from a low base is considered a sign of progress and globalization so is looked upon favorably. It is good for developing countries to an extent. Especially in case of India. Even though I said earlier India doesnt "need" to depend on foreign trade, it should work to increase its exports rapidly. Because for a group of countries such as India, whose currency has been artificially weakened against USD, it makes sense to sell more goods to USA and earn american prices rather than selling it at home and earning rupee prices.

Rupee's real value in an ideal PPP world roughly = Rs. 25/ US dollar. This is what the value "deserves" to be today if there were no artificial interference in the world.

However, in the current global world order, value = Rs. 75/US Dollar

This is where the difference in Indias PPP GDP ($11 trillion) and Nominal GDP (3.2 trillion) comes from.

Rupee is artificially down by 2/3rds or in other words US Dollar is overvalued 3 times compared to Indian rupee. It is not possible to overnight change these values without worldwide chaos and geopolitical friction.

So, next best thing is sell maximum amount of goods n services overseas and earn real higher value for these goods n services and avoid artificially lower rupee payments by selling domestically. You could sell a vada paav for Rs. 10 ($.13 USD) in India or you could export a packet of frozen Indian Burger to USA for $2 and make 1400% more. I buy $5 packets of frozen indian food here all the time.

As this process continues and eventually as more and more indian goods n services reach american shores, indian and american prices will converge and USD and Indian rupee will slowly reach a new equilibrium of trade flows where INR reaches towards its true value of Rs.25/USD over the years, everything else being equal. This meanwhile create lots of additional jobs and industries in India and will make GDP grow faster.

For all countries of the world with lowered currency values against USD, it makes sense to export until value reaches its true value. For countries with overvalued currencies, such as USD itself, it makes sense to import more and more from poor developing countries such as India because they are getting things partially free - at a lower than real rates. So you have been seeing USA having big trade deficit year after year and it is fine with it. Because it is advantageous to it. There is another aspect to trade, which is financial funds flow, basically change in investment position with respect to other countries but for sake of simplicity we will ignore it for now.

Coming back to trade ratios and its importance, I have noticed countries go thru 3 different phase while becoming from a poor, developing country to rich, powerful developed country.

Phase 1. Country is poor and just getting its economic development started. In this phase you are starting from a low trade ratio/GDP and any increase in trade % is good for the economy and country. This was USA till 1940s. USA was the biggest trading partner of the world and responsible for 50% of all of worlds GDP in world war 2. They reached there using the export based model and trading extensively with overvalued currency holding Europe during its phase of development.
China from 1980-2007. China had a huge economic expansion using this export led model and trade went from almost nil in 1980 to 60% of GDP in 2007 at its peak.
This is the phase India is in now. India is at roughly 30% now.

Phase 2
During this phase, countries have already developed sufficiently to go from low income to middle income and have achieved the required domestic industrialization and scientific know-how to reduce dependence on foreign trade. At this stage, countries try to increase size of domestic market and private consumption part of the GDP. As a result of this "rebalancing" Trade Ratio to GDP goes down. By this time your country's currency is close to reaching its true value against formerly overvalued currencies so there is no more incentive to export more n more. A benefit of reaching this phase is that your country has more strategic autonomy now because you no longer has to depend on goodness of other countries to allow your exports for survival. At this stage, big countries with superpower aspirations start working on critical core technologies and industries to achieve complete independence and start securing important resources. Perfect example is China. Before Global Financial Crisis in 2007, Chinas trade ratio-GDP was 60 % Today in 2020 it is much lower, at 30%
So, China went thu a period where it tried to increase trade ratio for 3 decades and then spent next decade 2007-2020 bringing it back down by increasing its private consumption parts of GDP. This was the right thing to do. As export led model had served its purpose and now its time to move on higher up the ladder. As predicted, China has recently started investing in core and future technologies such as quantums, AI, hypersonics, semiconductor fabrication to make itself completely independent and started BRI and debt traps to secure resources. So, China is currently at the end part of phase 2. India will reach this stage if we keep successfully implementing phase 1 during the next 15 years. That is another reason why I think INR will stay weak against the dollar for a few years, to encourage exports and industrialization and GoI wont be in a hurry to revalue rupee higher anytime soon barring unforeseen circumstances.

Phase 3
In this stage, the country has secured all of its critical needs and has access to all needed resources to become self-sufficient if needed,. Now is the time to reverse the tables vis-a-vis currency values. Now you are strong enough to rearrange the world order and impose your currency values and global financial architecture. In this phase you go from net exporting to massively net importing as your currency is now overvalued compared to others and you can exploit the poor developing Phase 1 countries by importing more n more things from them for cheap. You get an extra bonus if you are a reserve currency like US Dollar. You get fiat privileges to print away as much money as you want for no cost and offload all the debt on others. The world will be forced to absorb all this frivolous debt if it wants to stay a part of your designed financial architecture. USA is here. China is trying to reach this stage over the next few years. Sometimes things dont work exactly in sequence and you can make a big leap if you are a large country and happen to be at the right place at the right time. USA got lucky, at the end of world war 2, it kind of jumped from phase 1 to 3 because there was no other country left standing. In 1944 as WW2 neared its end and Britain, France, Germany, USSR and Japan were destroyed and bankrupt, USA took over the role of superpower by default and US made the famous Bretton Woods Agreement in 1944 that is still the bedrock of all of financial world today.

So, its possible for some country to skip some logical progression but normally most countries follow the above model of development from phase 1 to phase 3. India can reach stage 3 in 30 years or things can speed up if things align perfectly geo-politically and we play our cards right.

Sorry, for the long post. Please advice on better editing, formatting etc for future if found wanting.
Thanks for such a detailed post 😊.
And you explained everything in very easy language
 

Rxbanda

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Alcohol-based hand sanitisers to attract 18% GST: AAR The Authority for Advance Ruling (AAR) has said that a GST of 18 per cent will be levied on all alcohol-based hand sanitisers.
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Any update on this, or is this finalized? This is not a good move IMO.
 

Sehwag213

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Alcohol-based hand sanitisers to attract 18% GST: AAR The Authority for Advance Ruling (AAR) has said that a GST of 18 per cent will be levied on all alcohol-based hand sanitisers.
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Any update on this, or is this finalized? This is not a good move IMO.
There was already 18% gst. Media cresting sensational headlines
 

IndianHawk

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That lancer chart is very pessimistic. India is already very near to Germany. And recession is hitting Germany way harder than India. Germany will be overtaken by 2025 easily. By 2030 we will overtake Japan with 8-10 trillions gdp at the very least. As again recession will bite Japan way harder than India.

By2100 lancer itself predicted that India will have 200 million more working adults than china even as population falls worldwide including India so how will chinese economy be bigger than India ?? Not possible.
 

Hijibiji

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It's incredibly difficult for me to write anything new these days because I don't really know which thread is a good thread for new things that i see. BUT taking the chance anyway!

Saw an advertisement "SIPs for women". The caption is "Many women still don't like to handle investments. It's time this changed"

World is changing so fast! Sahi hai!
 

Abhijeet Dey

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In 2019 India was the leading importer of palm oil worldwide, with an import value of about 5.41 billion U.S. dollars.


Orangutans go into starvation mode with forest fires in Indonesia, study finds

220px-Orang_Utan,_Semenggok_Forest_Reserve,_Sarawak,_Borneo,_Malaysia.jpeg



India is the world's largest importer of palm oil, primarily from Indonesia. The fires that raze vast swathes of Indonesian Borneo every year are having a lasting health impact on the region's critically endangered orangutans that threatens them with extinction, a preliminary study has found.

Commercially available alternatives to palm oil


A very obvious way to replace palm oil would be the usage of liquid oils like rapeseed oil, sunflower oil or soy bean oil.
 

Rxbanda

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Finally, I get a better understanding of forex.
 

AsuraKiller203

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Can someone please explain or provide a reliable reference (which explains in common man language) for how RBI earns Forex?
Also, I believe Govt. must be having a war chest. Is it different from this RBI's reserves? And, is there any info disclosed to public about how big is our war chest?

Thanks.
In part of 1 this answer, I will talk about forex and how they are accumulated and used. In part 2 I will talk about India's war chest and our strategies for a war against China.

--------------------------------Part 1 ----------------------------------------------------

A central bank's forex size is meaningless without understanding the background and context: how they were earned? for what purpose are they structured? in what currency? who are the countries biggest trade and financial partners and their currencies? how is the forex meant to be offloaded? what are other monetary tools available to the country's authorities? Does the country have a fixed peg or a floating regime? What are the linkages between the country's central bank and other credit and banking institutions? What is the status of the country's own standing in global financial flows? And what is the country's geopolitical position? what is the status of the country's own currency abroad? Is it held by other central banks as reserves? Each of this factor has an affect that changes the real value of the forex held by a central bank. Country A with a certain standing on above parameters with $1 trillion has a different value and fire power attached to its $1 trillion compared to country B having a $1 trillion with a different standing on the above parameters. I will explain below.

Lets start with "What is the purpose of RBI's forex reserves?"

India's forex reserves are a Shock Absorber. That is the primary role for which they are created and held. External shocks coming from abroad can sometimes cause a domino effect that results in dis proportionally large domestic disturbances and hurt the economy. Usually these shocks are short term in nature but if you don't have the tools to manage them, they can do long term damage to the economy. So its worth investing in such tools and having sufficient forex reserves is the main tool for a developing country like India. What are some of the causes and forms of these external shocks?

Rapid undesirable currency movements
Sudden and large financial outflow or inflow
Speculative attacks on the country's financial system
Sudden change in a country's credit profile
Rapid change in value of stock and credit markets
Unforeseen change in relationships with countrys primary trade partners
Premature calling of countrys external debt
Any natural or man-made calamity

The most relevant for India are large swings in short term speculative financial flows and resulting swings in value of INdian Rupee vs. US Dollar. . We all know how foreign funds play a role in our stock market volatility. Another role for India's large forex that is less important now but was more important earlier is: being able to import a few months worth of essential goods and having enough forex to service any dollar based external debt.

Lets say if India did not have large forex, the following chain of events could happen: A large tsunami wipes out our exporting centers and as a result our exports are expected to go down over a few months without corresponding lowering of imports. This will result in lower supply of dollars in USDINR market. Something in low supply, rises in value, so USD can be expected to rise and INR can be expected to fall in value. Currency traders and financial speculators can take advantage of this situation. They can create large short positions against the rupee to try to benefit now from an impending certainty. Markets work on herd mentality. Once large bets are placed, it can cause even more speculators to join and create a stampede against the rupee. In this situation, the rupee can devalue by 50% in a couple days where areas, the natural effect due to calamity might have been just a 10% reduction in rupee over months. Now, What will be the secondary and tertiary effects of this? A sudden loss in rupee strength will cause capital flight out of the country out of fear of further weakening, stock markets collapse, inflation rises, investor mood sours, many foreigner investors rethink their plans to invest in India and India loses billions of potential new investment for years. Foreigners liquidating Indian assets puts further downward pressure on rupee and the cycle continues and it becomes a self-fulfilling prophecy. Now the speculative shorts have been proven correct and are in the money big time. Domestic business formation may take a hit because there is no certainty and visibility regarding profits and purchasing power of rupees earned. Once such a sentiment takes hold, recovering from such a shock might take years and reduce GDP by many points unnecessarily. In this situation, what is the govt to do? It still has to import essential goods from abroad but now it has to pay double the price or face riots. Its in a bind. This gives the speculators leverage to demand anything they want from the govt, forcing it to give away choicest national assets at firesale prices and other preferential treatment. Years of economic gains could be lost in a few days by speculators holding the government hostage.

Now, if there was no speculative attack, the loss in exports could be made up internally by building new exporting centers or by adjusting and substituting essential imports over a few months so that supply and demand can naturally reach a new equilibrium with minimum pain to the economy and society. But this requires time. So what gives this time to the government? Tools such as a large forex reserve to fend off speculative attacks. In this example, when reduced exports reduced supply of dollars, RBI could release more dollars into the markets to stabilize USDINR value in the short term, limiting rupees decline to 10% which would have been naturally. They can do other sterilized and unsterilized interventions in the domestic market also to achieve the desired outcome of limiting rupees decline. This will stop the whole chain of events which could cause much greater total damage to the economy than the worth of money spent by RBI in stabilizing USDINR. So, its best to think of RBI's forex reserves as an insurance policy. Like nukes, having large forex reserve itself has a deterrent effect and prevents speculators from turning minor shocks into major shocks for profit. Speculators are everywhere in the world, there is no way to hide away from them in a globalized, free, capitalist society. High volatility and high risk is the price to pay to live in a high growth world. Even the US suffers speculative attacks from time to time. I will write a new post about some of the major speculative attacks of recent times. So how large of a forex reserve is large enough to ward off speculators? That depends on many factors and I will touch upon that later in part 2.

Keep in mind that any central bank can manipulate currency values in the short term only. In the long term, currencies will find their true, natural values based on the fundamentals as mentioned in my previous reply.

What are other roles of RBIs forex reserves?

They strengthen the government's fiat and enables the govt. to carry out its financial writ domestically. If the RBI has large forex, it adds credibility to its actions and gives more power to its other tools such as interest rates, bank deposit cash ratio etc.

The preamble of RBI describes its main function as:

"to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage; to have a modern monetary policy framework to meet the challenge of an increasingly complex economy, to maintain price stability while keeping in mind the objective of growth. "

The third function of RBIs forex is the underlined part. You always want to make the currency rates work to the advantage of your nation. When a GoI agency or an Indian businessman decides to do a strategic purchase abroad, he tells the RBI what the ideal currency range for his deal is in a given time-frame. Having a strong central bank have his back gives Indian businessman an upper hand in foreign contract negotiations. Thus RBI has some visibility on major upcoming foreign transactions of governments, banks, institutions and individuals and can predict short term orders books and flows. With large enough pre-existing forex reserves, it can temporarily influence the currency direction to the nations benefit considering the aggregate confluence of all competing factors.

Perception of having enough forex allows GoI to argue for higher ratings from international rating agencies so GoI can issue bonds at a lower rate.

These are minor roles, the main role of RBI's forex is to serve as an insurance policy against undesired volatility.

Now to the pertinent question of "How RBI earns forex?"

To understand this, lets get to basics first.

1)
What is "money" "currency" to a government? It is a liability. To an average person holding it, it is an asset but to the issuer of the said money it is a liability. Money is just a claim on resources. The currency is an "IOU" from the govt to the citizen. In the old days, you could return the IOU to the govt and get a pre-determined amount of gold in exchange. And you could trade that gold for goods and services you need. Nowadays, You can return that IOU to the govt and in return get only another IOU since we are on a fiat system. What is the value of holding this IOU then? You can trade this IOU for goods and services in the domestic economy. So we are cutting out the role of gold as a middleman in the new fiat system since 1971. This system works only as long as citizens believe other citizens will honor IOUs for goods and services and there always will be sufficient and proportionate amount of goods and services available in the economy in relation to the total IOUs in the economy. This basically entails citizens trusting that govt will always be able enforce this happens. It is basically replacing gold with increased trust and confidence in the government. For the govt, the faith that people put in its currency is the (intangible) asset and the mandate that IOUs always be convertible into useful goods and services is the (intangible) liability. This is basically government's fiat. This fiat gives the government (RBI) powers to infinitely create or destroy domestic currency as it wishes.

2)
Second, know that: Balance of Payments = Current Account (exports, imports) + Capital/Financial Account (FDI, Foreign portfolio investments etc.) Balance must always equal 0. In other words, Current Account Must always equal Capital Account. India persistently runs current account deficits and balances them by running capital account surplus.

3)
Third, the short term tools available for Govt to tinker with these are:
Import/Export Controls, Foreign investment controls, Changing domestic interest rates (monetary policy), Changing currency rate (forex intervention), Changing indian banks cash reserve ratio (monetary policy)

4)
Know, that principle of "Impossible Trinity" governs all central banks policies. It states that it is only possible to have two of the three of the following at the same time:
1595647391345.png


Because they are interconnected and changing one affects the other. In other words, If you have free movement of capital (like India,) doing forex intervention to set currency rate will change domestic conditions, which will force you to do monetary intervention as well. These are second and third order effects. I will talk get back to them a little later.

5)
There is a lag period for second and third order effects to show up. All central banks interventions and monetary policy tools are basically about using the lag period to reduce volatility in one part of the triangle to give the economy time to adjust to the new reality. So its best to think of a central banks job as continuously playing the role of whack-a-mole on a triangle to reduce (whack) unexpected sources of volatility so they dont become a crisis.
Once you get this, understanding the rest will become easier.

Now lets get to accumulating forex reserves.

RBI like all central banks can print and destroy domestic currency but cant print foreign currency. So, It buys dollars from the market which is places such as forex dealers, other central banks, commercial banks etc. Forex is the largest trading market in the world comprising of individuals, institutions, banks and governments with daily turnover of trillions of dollars. To be precise, RBI buys lots of short term US treasury bills because they are the most liquid and widely traded risk-free instrument in the world and are a close proxy for the dollar. US treasuries can be quickly turned into US Dollars when needed. But for purposes of simplicity, we will assume that RBI simply buys US dollar currency.

When RBI buys US Dollar (accrues forex), it pays with Indian rupee. It has two options for where that Indian Rupee comes from:
Option 1) It can simply print Rupee and do nothing else. This is called unsterilized operation.
Option 2) Instead of printing, It can withdraw the money circulating in Indian economy to pay for it. This is called sterilized operation.
It withdraws money by issuing new bonds in the domestic market. When indian citizens buy these bonds, they turn in indian rupee (currency) to RBI thus reducing total amount of rupees in the economy. RBI can also use other options to withdraw rupees from the economy such as tinker with indian commercial banks reserve requirement and other ratios, which would have the effect of reducing the money available to indian banks to lend to citizens in the domestic market. Thus serving the same goal of withdrawing rupees from circulation. For this example we will assume RBI buys US Dollar by issuing new bonds.

Lets look at RBI balance sheet of 2019. In accounting every asset has to be matched by a liability. From RBIs page:


I will summarize it here and convert in US Dollar for simplicity:

AssetsLiability
Total : $600 billionTotal: $600 billion
of which:

Forex $430 billion
Gold $20 billion
Domestic Bonds $140 billion
Other $10 billion
of which:

Notes in circulation (currency)
$300 billion.
Bank Deposits $120 billion
Other $180 billion

Each option has its pros and cons. Lets Consider option 1:

Assume USDINR rate of 50

RBI prints Rs.5000 Crores and buys US $1 billion from the forex market. Now RBI has additional $1 billion forex as assets on its balance sheet and has corresponding Rs.5000 Crores listed as liabilities. What will the eventual consequences be? Rs.5000 crores will eventually find their way in India because INR is only accepted in India, it will enter into circulation and increase money supply and inflation at some unknown date in the future. So, you see its "free money" in the short term but in long term it has a price. So second order effect of option 1 is higher inflation.

Option 2: RBI does everything in option 1 but then does one more step. RBI issues Rs.5000 Crores bond and Indian public buys it, giving Rs.5000 Crore to RBI and reducing Rs.5000 Crores from circulation. Net effect of this is that there will be no increase in money supply, domestic money supply is not affected. Hence this operation is called "sterilized" because this sterilizes the economy from second order effects. But in a longer term, third order effect will be increase in total govt bonds which will affect RBI's capacity to manipulate interest rates in the future. So there is no "free lunch" economics. If you do an intervention today, at some point in future, you have to pay for it with something else. The whole game is about utilizing the mismatch in short term actions and long term affects to reduce volatility in the present and give time to the underlying economic fundamentals to adopt.

RBI decides which option to use to purchase dollars at an given time depending on underlying conditions. If increasing inflation is against RBI's current monetary goals, then go with option 2. If economy is in deflation, it will be useful to have additional injection of liquidity, so option 1 of printing rupees to buy forex is fine . Lets assume inflation is too low, and increasing inflation is the goal of RBI. What other tools RBI can use? It can lower interest rates a few points and lower commercial banks reserve ratio. Point to note is that money printed by RBI is just a substitute for other policy tools at RBIs disposal to reach the same end-goal. Thus "money" by itself has no meaning or value to RBI, it just an additional tool to achieve underlying economic objectives. Here $ 1 billion forex reserves could be an equivalent proxy for a 2 percent point lowering of interest rates. The end result of both actions will be the same: increased amount of rupees in circulation and more inflation. Thus, hopefully you can begin to see any size of $$$ forex on balance sheet is just a proxy for having and not having other monetary levers and forex size by itself gives you no meaningful information about firepower of a central bank.

If a central bank has other more powerful tools such as strong monetary policy tools, good ability to impose capital and trade controls when needed, extremely adoptable economy etc. then it doesn't need to have large forex reserve to reach the same end goal of changing USDINR values. For example instead of buying dollars to reduce rupee value to encourage exports, Govt could instead lower Indian interest rates in relation to international rates, which would result in an outflow of investment from India to seek higher returns abroad, which would increase supply of rupee and increase demand of Dollar, thus reaching at the same end-goal of lowered Rupee against dollar. But Then it has to deal with other effects of lowered Indian interest rates. Basically the tool and policy mix available to the Govt determines how large of a forex reserve size it needs to do its job of a shock absorber. In other words, you could say large forex reserve is Indias way of making up for weakness in other tools and policies. More on this in part 2.

See The US Fed Reserve (Fed) and European Central Bank (ECB). The Fed has only $100 billion and ECB only $70 billion forex reserve. But you wouldnt say these are weaker central banks than RBI. They dont need a large forex reserve because they have other tools and options that work much better for their policy objectives. They also have highly developed and integrated financial economies and their govts are able to do "financial engineering" / "financial trickery" at a much better level to manipulate the currency rates and markets to reach the desired outcome. Hence they dont need to always carry a large forex reserve. These foreign banks also have more aggressive (unofficial) mandates compared to RBI such as running asset bubbles, optimizing stock and bond values and maintaining the current western financial world order.

Now you see how RBI can accumulate and use Dollars to change USDINR rates in the short term to reach a desired end-goal. Lets talk about when.

During which periods can RBI effectively accumulate and use forex (US Dollars)?

When RBI buys dollars and sells Rupees in the forex market, it will lead to an increased supply of rupees and lowered value of rupee against the dollar. RBI may do this because either it wants a lowered rupee for short term objectives or it wants to accumulate forex reserves to use (sell) at a future time. Lets say RBI wants to accumulate a huge forex dollar reserves today because it foresees larger than usual volatility in the years ahead. RBI can sell the dollars at that point in the future to reduce volatility. So, it goes to the forex market today. I said above that forex is very large market with trillions traded every day. But most of that trade is of US Dollar, Euro, Yen and Pound. Indian rupee is thinly traded in comparison. If a large player such as RBI is active in a thinly traded market, it distorts the values by its sheer size of orders and RBI wont be able to get the rates it wants if there isnt a sufficient large liquid underlying market. So, RBI can only effectively buy large amounts of dollars when theres a large supply of available dollars in the USDINR market. In India, this happens when theres a large inflow of foreign investment and portfolio funds into India. These foreigners bring their dollars to sell to the forex market and in turn buy rupees to invest in India. You can see proof of this over the last year:
India has been receiving large capital inflows and RBI has been using them to increase its forex size. Secondly, if RBI did not use this situation to accumulate forex, Rupee would have appreciated against the Dollar. So, by buying dollars over the last year, RBI built up its forex reserves and stopped the rupee from appreciating. Thus rupee stayed weak against the dollar.

The RBI can do the opposite when situation reverses. If theres a large capital outflow, it would naturally lower the value of rupee. The RBI then can sell dollars (use up reserves) if it wants to stop the rupee from lowering. So, basically RBI does counter-trend transactions in the forex market to reduce volatility of the USDvsINR rate in the short term.

So, What are the levels at which RBI will step in to lower or increase Rupees value against the dollar?

Having declared a certain value puts the Govt in a bind and allows speculators to "front-run" RBIs trades for profit. So India has no declared desired value for INRvs.USD and India is committed to a freely floating exchange rate regime (international norms) so no one knows. Having some secrecy and unpredictability also helps RBI in efficiently achieving its policy objectives. Indian govt and RBI have very limited objectives in setting the short term currency rate . RBI is only supposed to intervene in the market to reduce excessive volatility of the rupee against other currencies in either direction. RBI doesn't define excessive but its generally seen that RBI's tolerance level is no more than +/- 10% Rupee movement in a week.

Technically, all the worlds democratic countries have separation of powers between elected Govts and central banks but this is largely academic. All the countries govts usually have an undeclared understanding with their central banks about the general direction in which they want to see the countrys exchange rate in the medium term based on national goals. In India, it seems theres an implicit understanding to keep the rupee weak for a few years to support the export sector of the economy.

In reality, besides buying currencies on the spot market, RBI also uses other fancy instruments of the forex market such as swaps, futures, forwards, options etc
I have only summarized the steps involved in RBI buying and selling forex. In reality there are a few more legal steps involved due to delegation of authority between Ministry of Finance (elected govt) and RBI. These are just accounting entries and technicalities and they do not affect the larger picture. Let me know if you want these steps explained in detail. Since RBI is also Banker's banker, Banker of the Central and state Govts, it has an MoU with the Govt on the kinds of bonds it can hold and sharing of the resulting interest and profits. You can find more on this on the RBI page.

In Part 2, I will talk about the other perimeters mentioned in the beginning and tie up the linkages between India's finances, economy and geopolitics as it relates to India's War Chest.

I have found that this page has the most comprehensive data of economic indicators anywhere on a single page. Use the drop menu on the right to see in a chart format.

Even the homepage has a good running tally of the basics of all major economies at the bottom of the page:
 

Prashant12

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