The Hindu Business Line : You bet, forex is the bigger asset!

IT is common knowledge now that the country's foreign exchange reserves have increased spectacularly over the past decade — from $5.83 billion in 1990-91 to $21.69 billion in 1995-96 and $54.11 billion in 2001-02.

What is less known, however, is the fact that the value of the Reserve Bank of India's (RBI) holdings of dollars, pound sterling, deutsche marks and other foreign currencies (including gold) today exceeds the total amount of rupees in circulation with the public and banks!

As on April 19, 2002, the aggregate rupees in circulation, which includes the currency with the public as well as cash with banks, stood at Rs 2,60,834 crore. On the other hand, the corresponding value of RBI's net forex assets were higher at Rs 2,69,146 crore.

The 1990s witnessed an unprecedented build-up of RBI's forex assets relative to the domestic currency in circulation, with this proportion rising from 14.4 per cent in 1990-91 to 60.4 per cent in 1995-96 and 90.4 per cent in 2000-01. 2001-02 saw the ratio of net forex assets to currency in circulation (NFA/C) touch 105.2 per cent.

What does an NFA/C ratio in excess of 100 per cent signify, apart from the symbolism that could be attached to the country today having more stocks of dollars and pounds than rupees (it is a different matter though that the former is held in RBI's custody and not in circulation among the public and banks)?

According to RBI economists, a rising NFA/C ratio during a period of rapid foreign capital inflows is indicative of prudent monetary management. Whenever huge inflows trigger purchases of foreign currency by the central bank, there is a corresponding release of rupee resources into the economy.

This additional liquidity — `reserve' or `base' money, in monetarist parlance — is manifested either as currency with the public or higher cash reserves of banks.

Banks, in turn, lend the excess reserves to the public, which retain a part of this as currency and deposit the rest with banks, which gets further lent and re-deposited, and so on. This is the familiar money-multiplier process, wherein a unit of `base' money (released by RBI) generates multiple units of money supply in the economy through successive rounds of deposit-cum-credit creation.

Normally, an increase in RBI's net forex assets would have entailed, at the least, an equivalent expansion in currency, assuming no dramatic shift in the public's preference for keeping deposits vis-a-vis holding cash (the currency-to-aggregate deposits ratio has, in fact, hovered around 19-24 per cent over the last decade). What has taken place, however, is a significant surge in the NFA/C ratio.

This only goes to show one thing: The massive build-up of RBI's net forex assets has been simultaneously accompanied by curbs on expansion in its domestic assets, restraining overall reserve money (and, in turn, currency) growth.

Thus, between 1990-91 and 2001-02, RBI's net forex assets have gone up 33-fold, from a mere Rs 7,983 crore to Rs 2,63,969 crore. During the same period, the central bank's outstanding net domestic assets — reserve money minus net forex assets — have actually shrunk from Rs 79,796 crore to Rs 73,856 crore! This, of course, has been courtesy the virtual brakes put on RBI's credit to the Government, resulting in reduced `monetisation' of the latter's deficits.

In 1990-91, net RBI credit to the Centre formed 98.8 per cent of the outstanding reserve money, with this share falling to 61.1 per cent in 1995-96 and 43.2 per cent in 2001-02.

Correspondingly, the contribution of net forex assets in reserve money has risen from 9.1 cent to 38.1 per cent and 78.1 per cent, thereby demonstrating the predominant role of `dollars' in the conduct of monetary policy today.

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