Despite recent issues with a slowing economy, strong macroeconomic indicators due to an increasing portfolio and FDI inflows have meant that India’s forex reserves have been growing at a fair pace. They continue to scale new heights. Several commentators have made comparisons with China in how India might exponentially build its forex reserves in the future. However, despite several similarities (such as providing a stimulus), as highlighted below, this forecast is inaccurate due to the differing nature of their economic and political systems.
Primary Goal
In macroeconomic terms, India has consistently run a current account deficit while China has run a surplus. This means India imports more than it exports. Its balance of payments is shored by an FDI and other inflows into its capital account. Therefore, it needs forex reserves to cover its imports during times of turbulence in an increasingly volatile global economy, shaped by rapidly changing investor sentiment. In contrast, China exports more than it imports. It uses its forex reserves to maintain its currency at a fixed exchange rate to the US dollar to maintain a competitive advantage in trade. Although India does not have a fully floated or fixed exchange rate, its reserve bank pegs the Rupee to a basket of global currencies (such as the Yen, Euro and Pound) . It allows it to appreciate or depreciate within a range by placing restrictions on transactions and buying/selling the currency as the need arises, which requires considerably less monetary resources.
Revenues and Spending
There are also differences in the nature of the economies. The Indian economy is dominated by the private sector detached from the government. In contrast, the Chinese economy is dominated by state sector entities. Due to weak income tax collection from corporate entities, a lack of a large taxpayer base and populist schemes needed to build political capital, India needs robust forex reserves to potentially bridge any sudden spike in the budget deficit arising due to high volatility in revenues. Being a centrally planned economy, the Chinese government does not face such issues as it has a better oversight of the economy and surety of income streams.
Foreign Relations
India shares cordial relations with its major export destinations, regardless of regime, namely the US, the EU and the UAE. This cannot be said of China, whose political relations with its number one export market, the US, is prone to stress due to the country’s large trade surplus. China will be mindful of the Plaza accord, in which the US buffered its markets by depreciating its currency against the yen and the Deutsche mark. By holding large amounts of American government debt and currency (in its forex reserves), China can negotiate better and holds a potent weapon or leverage in case of a trade war – an outcome increasingly likely to occur if political rhetoric is to be believed.
Conclusion
In summation, India should not accumulate its forex reserves beyond a certain point as it faces different socio-economic dynamics to China. Rather, it needs to add depth to its tax base and aim to run a balanced budget and boost exports via reforms, reducing its trade imbalance; reliance on building forex reserves papers over these structural issues. On the other hand, China will eventually need to fully float its currency, thereby reducing its surpluses to politically acceptable levels. Its focus must be on investing the said reserves to provide better returns in cushioning against a rapidly ageing population and a consequent drop in the workforce.
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