Key Points
Raghuram Rajan, former governor of Reserve Bank of India (RBI), recently called upon emerging market economies, including India, to build up foreign exchange reserves as protection against the populist and extreme" policies in advanced countries..
As of 26 January, the central bank boasted $616.7 billion in reserves, a figure that has impressively doubled over the last decade, positioning India among the world's top 10 countries in terms of reserve holdings..
The "import cover" ratio, which compares reserves against monthly imports to gauge how many months of imports can be sustained solely on reserves if other foreign exchange inflows cease, has traditionally served as a key macroeconomic benchmark..
In the years preceding the crisis, import covers for Thailand and Indonesia were above the three-month accepted threshold, but short-term external debt ballooned to exceed reserves..
Given the limitations of these thumb rules, the IMF goes one step ahead and adds two more indicators that impact balance of payments (BoP): non-debt external liabilities and broad money. These, too, dictate how much of reserves an economy needs to protect itself: a decline in non-debt liabilities (such as foreign portfolio inflows) calls for more reserves to compensate for low dollar inflows on the capital account; more of broad money needs more reserves to cover the increased risk of outflows of residents deposits..
