Thread.

There's some discussion on Indian #EconTwitter about our high forex reserves and what to do WITH it.

I think that's looking at the issue from the wrong end. The question should be: what to do ABOUT it?

After all, the reserves are not accumulating by themselves.

1/6

The reserves are increasing because the RBI is firefighting.

It is trying to keep exchange rates from appreciating sharply.

This pressure on exchange rates is due to two factors. Fall in imports (low demand for forex). Rise in inward capital flows (high supply of forex).

2/6

So why not (temporarily) remove all import tariffs on intermediate and capital goods?

This will surely incentivize private investment and growth.

With low imports currently, there's hardly any revenue loss.

And if this pushes up imports, then that's less pressure on RBI.

3/6

Also, if there is undue pressure on exchange rates, then even the IMF now supports some capital control.

So why not use some capital control to restrict the most foot-loose flows temporarily.

This again will ensure less pressure on the RBI to buy up forex.

4/ 6

The point is that the RBI should not have to accumulate more and more forex passively, simply because neither the private sector nor the government has any demand for the forex that is flowing in.

This situation may be temporary but we do not know how long this will last.

5/ 6

Reserve accumulation also has its cost. It will need sterilization at some point. That will increase the supply of govt bonds in the secondary market, making govt borrowing more costly.

So the question is, why not take steps to minimize the need for reserve accumulation?

6/6