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100 Expected Questions

Prelims Capsule


Foreign Investment in India

Foreign Investment in India


GS 3 || Economy || Banking & Financial Sector || Forex Market

Why in news?

  • The country’s foreign exchange reserves rose to a ten-month high of $411.91 billion as on March 29, 2019.

Forex reserves

  • Rupee instability: While forex reserves had hit a high of $426 billion in the week ended April 13, 2018, it witnessed a steady slide over the following months and went down to $392 billion in the week ended October 26.
  • This was on account of the RBI intervention to manage the rupee –
    • which had fallen to its all time low of 74.34 against the US dollar, in line with the rising crude oil prices,
    • and the central bank had to intervene to stem the local currency’s slide against the dollar following capital outflows from debt and equity markets.

Recent developments

  • Forex reserves are now highest since $413 billion recorded in the week ended June 8, 2018.
  • The inflow of foreign capital into India’s stock market in the month of March hit a high of $4.89 billion, the biggest foreign inflow into Indian stocks since February 2012.
    • As a result, the stock market rose a solid 8% in March.
  • Foreign investment in Indian equities stood at $2.42 billion in February, as against a net outflow of $4.4 billion during the same month a year earlier, and is expected to be strong in April as well.
  • Record foreign portfolio investment (FPI) inflows and a $5 billion rupee-dollar swap window by the central bank added to the forex kitty.

Other driving factors

  • Both cyclical and structural factors are behind this sudden uptick in foreign investment that has helped the rupee make an impressive comeback.
  • A fall in crude oil prices in recent months and appreciation of the Indian rupee vis-à-vis the dollar also helped in steady rise forex reserves in recent weeks.
    • The rupee has appreciated by about 7% since early October, when it was reeling at around 74 against the dollar.
    • The appreciating rupee also increases returns on foreign investors pumping money in Indian markets, as it helps boost their returns in dollar terms.
  • A rupee-dollar swap by the RBI last month also added to the forex reserves.
    • In order to inject rupee liquidity, the RBI on March 26 conducted an auction to buy $5 billion from the market and simultaneously sell it back to the same counterparties effective March 2022.
    • The amount of dollars that has been mopped up via these operations will reflect in the banking regulator’s foreign exchange reserves for the tenor of the swap while also reflecting in RBI’s forward liabilities.
    • Meanwhile, the system gets rupee equivalent liquidity for the same amount and for the same duration. The central bank will conduct a similar swap again on April 23.
  • Last year, India received more foreign direct investment than China for the first time in two decades.
    • While the Chinese economy has been slowing down considerably in the last one year, India has emerged as the fastest-growing major economy.
  • Other short-term reasons may also be behind some of the recent inflow of capital into the country.
    • For one, there is a sense among a section of investors that their fears of political instability are misplaced.
    • More important, there are clear signs that western central banks have turned dovish.
      • Both the Federal Reserve and the European Central Bank, for instance, have promised to keep interest rates low for longer.
      • This has caused investors to turn towards relatively high-yielding emerging market debt.
    • Indian mid-cap stocks, which suffered a deep rout last year, are now too attractive to ignore for many foreign investors.

Way ahead

  • The return of foreign capital is obviously a good sign for the Indian economy. But policymakers need to be careful not to take foreign investors for granted.
    • Other emerging Asian economies will be competing hard to attract foreign capital, which is extremely nimble.
    • Any mistake by policymakers will affect India’s image as an investment destination.
  • To retain investor confidence, government will need to increase the pace of structural reforms and also ensure proper macroeconomic management with the help of the Reserve Bank of India.
    • Long-pending reforms to the labour and land markets are the most pressing structural changes that will affect India’s long-term growth trajectory.
    • The high fiscal deficit of both the Centre and the State governments and the disruptive outflow of foreign capital are the other macroeconomic challenges.
    • These are some issues that need to be solved sooner rather than later.

Additional info

Forex reserves of India

  • The reserves are managed by the Reserve Bank of India for the Indian government and the main component is foreign currency assets.
  • Foreign exchange reserves facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India.
  • Composition:
    • Reserve Bank of India Act and the Foreign Exchange Management Act, 1999 set the legal provisions for governing the foreign exchange reserves.
      • Reserve Bank of India accumulates foreign currency reserves by purchasing from authorized dealers in open market operations.
      • Foreign exchange reserves of India act as a cushion against rupee volatility once global interest rates start rising.
    • The Foreign exchange reserves of India consists of below four categories:
      • Foreign Currency Assets
      • Gold
      • Special Drawing Rights (SDRs)
      • Reserve Tranche Position

Mains question

  • “Doubts over the robustness of the GDP calculation method notwithstanding, rise in forex reserves clearly suggest that investors expect India to be a major source of global growth in the coming years.” Comment.