India's foreign currency wallet is becoming fatter by the day. Heartening for a country that just a decade ago was virtually scrounging for dollars to meet its obligations. But plenty can also be problematic, and the Indian Government is fast realising this.

In the past 12 months alone, India has added $18.8 billion to its foreign exchange reserves-the amount of external assets readily available with a country's central bank-which now stand a tad below $64 billion. In fact, 2001-2 saw the highest accretion ever in a financial year when forex reserves climbed from $42.3 billion to $54.2 billion. Close to $10 billion has already been added in 2002-3, more than five months away from the end of the financial year. This is a magical rise from the lows of $970 million that the country's forex reserves had touched in February 1991. The figure reached $5.8 billion (of which $3.5 billion was in the form of gold deposits) by the end of 1990-91 and $32.5 billion, or almost half of what it is today, in 1998-99. Today, gold (which the country had been forced to pledge a decade ago) accounts for only $3.3 billion of India's foreign exchange reserves, $60.9 billion being in the form of foreign currency assets. It's a war chest as big as that of Poland, Hungary, Israel and South Africa put together.

Finance Minister Jaswant Singh RISING BURDEN India's forex reserves have crossed Rs 3,00,000 crore and are growing by almost Rs 7,000 crore a month

THE REASONS Foreign exchange reserves are rising because: NRI deposits have piled up to $ 26.30 billion Meagre growth in imports has reduced dollar demand Higher than global interest rates lure foreign investors FDI inflows at $4 billion Corporates seek dollar loans at rates much lower than rupee loans THE PROBLEMS The pile up has become counter-productive because: RBI has to buy dollars to prevent Re value from rising The reserves are invested in gilts of developed countries fetching returns of only 2-5% whereas the government pays an average of 10% interest on its borrowings THE SOLUTIONS To clear the forex glut, the Government could: Reduce import duties Raise $5,000 a year limit on purchase of forex Allow Indian companies to invest more abroad. Invest in export promotion. Allow corporates to hedge their risks in global markets on domestic transactions too

RBI Governor Bimal Jalan

"Jaswant and Jalan have to find ways to make this costly corpus more productive."

What fuelled this spectacular rise? The general perception is that the steep rise has been prompted by non-resident Indians (NRIs) flooding Indian banks with their earnings abroad. NRI outstanding deposits have risen by $3 billion from $23 billion on March 31, 2001 to $26.3 billion on July 31 this year and are believed to be rising further. Plunging global markets have meant that NRIs see better returns on investments in India where interest rates are much higher. Moreover, stringent checks on bank accounts in most countries post-9/11 has meant that some of the money which flowed out of the country is now coming back.

"NRIs are seeing great advantage in putting their money in India rather than in other global markets where interest rates are low. Not only are the returns higher here but there is also much lesser currency risk and a more stable environment," says Jamal Mecklai, CEO, Mecklai Financial & Commercial Services. "To top it all, the Reserve Bank of India (RBI) was aggressively buying dollars since the beginning of the year to keep the rupee weak to boost exports and this resulted in a surge in forex reserves." Aiding the trend were higher foreign direct investment inflows ($4 billion in 2001-2), relatively stable FII inflows ($2 billion in 2001-2), no surge in imports and a rush to raise money through dollar denominated loans (owing to lower interest rates) by corporates.

As dollars continue to flow in, the question now being asked is whether India's wallet has become too fat and whether it should shed some weight to push through more economic reforms. The challenge before Finance Minister Jaswant Singh and RBI Governor Bimal Jalan is to find ways how this huge corpus can be made productive. There are no easy answers to these questions. Y.V. Reddy, former RBI deputy governor and the man responsible for pushing through significant financial market reforms, in a recent speech, described the period 1990-2002 as a journey from "agony to comfort" vis-a-vis foreign exchange reserves. Reddy was among those who had to ensure that given the very low level of forex reserves in 1990-91, there was enough cash balance to permit foreign exchange payments of even $1 million. "In such a predicament, the threat of national humiliation as well as discomforting relations with foreign agencies obviously touched on personal pride," he recalls.

Perhaps this is why, even though India has come a long way from those days, the fear of a repeat has made the Government cautious of freeing exchange controls. Even as it sits on forex reserves worth 15 times the country's monthly import bill, it has no clue to what is an adequate level of forex reserves. The estimates range from $30 billion to $50 billion. "The scars of 1990 run deep. Added to that scare was the east-Asian meltdown of 1997. But the time has come to loosen the strings," says Bibek Debroy, director of the Rajiv Gandhi Institute of Contemporary Studies.

Since a large chunk of India's forex reserves are invested in government securities of developed countries (where interest rates can be as low as 2 per cent per annum), the country is bearing a heavy cost for maintaining these reserves.

Most experts believe that there is now an opportunity for the Government to push through some economic reforms. For instance, it can cut import duties to encourage imports by companies and ease restrictions on Indian companies to invest abroad. Besides, the foreign exchange can be used to promote Indian exports abroad. As former finance minister P. Chidambaram says, "Given the level of forex reserves, a boost can be given to Indian exports through an India Brand Equity Fund."

"We are missing a great opportunity to give investments a fillip in the country," says R.H. Patil, chairman, Clearing Corporation of India Ltd. "In a way the zooming forex reserves indicate that these are not being absorbed in investments being made in projects in the country."

Another reform waiting to happen is capital account convertibility. The RBI has relaxed foreign exchange controls significantly in the past few years. You can now invest in a mutual fund scheme which invests your money in international stocks or pay in international currency through your domestic credit card. But capital account convertibility has been put on the backburner. "There is a need to reset the time-table for capital account convertibility," says Chidambaram. Says Jairam Ramesh, member of the Congress's economic cell: "Capital account convertibility poses risks but it also disciplines governments and forces them to undertake reforms they would otherwise not take up."

An RBI committee on capital account convertibility appointed in 1997 had set four criteria for moving to full convertibility of the rupee in three years' time. These included an inflation rate of 3-5 per cent, forex reserves for at least six months of imports plus a year of debt repayment, a fiscal deficit of 3.5 per cent of GDP and bank non-performing assets of no more than 5 per cent of their total deposits.

The last two criteria have not been achieved yet and are unlikely to any time soon, ruling out a sudden shift to full convertibility. But the burgeoning forex reserves and the huge costs they entail are certainly a compelling reason for the Government and the RBI to free foreign exchange of controls.