India’s Foreign Reserves and Global Risk
Chetan Ghate,
Kenneth Kletzer and
Mahima Yadav
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Kenneth Kletzer: University of California
Mahima Yadav: Indian Statistical Institute – Delhi
No 168, NCAER Working Papers from National Council of Applied Economic Research
Abstract:
India accumulated a sizable stock of foreign reserves over the past two decades, in common with many other emerging economies. Its current reserves comfortably surpass conventional thresholds for adequacy used by the International Monetary Fund and others. An assessment of whether the stock of reserves is appropriate should depend on an evaluation of the benefits and costs of reserves looking forward. Reserves provide self-insurance against sudden financial outflows by non-resident investors or resident savers and liquidity for managing exchange rates. While India’s reserves appear to be ample for meeting both these needs, additional reserves can reduce vulnerability to capital flow reversals that can be crisis inducing. The empirical analysis of India’s external portfolio capital flows finds that reserves lower outflows in the event of global financial distress at the margin. Reserve holdings reduce the volatility of portfolio debt flows in response to relative policy interest rate shocks. The results indicate that additions to reserves reduce the economy’s exposure to global financial risk. The precautionary benefits of reserves could well increase as India becomes further integrated to international financial markets. Estimates of the costs of holding reserves give evidence that increases in the reserves to output ratio reduce the risk premium on reserves, so that the sovereign interest rate spread overestimates the marginal cost of reserves.
Keywords: Foreign exchange reserves; foreign portfolio flows; precautionary reserves; global financial shocks. (search for similar items in EconPapers)
JEL-codes: E52 F31 F32 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2024-05-24
New Economics Papers: this item is included in nep-cba, nep-ipr, nep-mon and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:nca:ncaerw:168
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