Business Today

Huge forex reserves to cushion Indian economy from US downgrade

A finance ministry official did not rule out the possibility of interest rates in the international market going up, which would make it more costly for India to finance its short-term debt.

S.P.S Pannu   New Delhi     Last Updated: August 10, 2011  | 11:31 IST

The finance ministry seems to be on a wait and watch mode after the downgrading of the US credit rating from AAA to AA+. A senior finance ministry official told MAIL TODAY: "We do not expect a major economic fallout after the US downgrade by rating agency Standard & Poor's but the picture will become clearer when the stock markets open on Monday."

He pointed out that in case the uncertainty created by the developments in the US result in an outflow of foreign funds, this may lead to losses for investors in the stock market.

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But as far as the Indian economy is concerned, no major problem is envisaged as the country has accumulated huge foreign exchange reserves.

"In the worst case scenario, any major flight of capital due to foreign institutional investors pulling out of the country would be in the $20-30 billion range while the country's foreign exchange reserves are at a comfortable $300 billion, which is more than sufficient for financing India's trade deficit," he explained.

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"However, given the strong fundamentals of the Indian economy any exodus of foreign investors from the equity market could only be a temporary phenomenon," he added.

The official did not rule out the possibility of interest rates in the international market going up, which would make it more costly for India to finance its short-term (six monthly) debt, used mainly for trade credit.

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The country's short-term debt currently comprises 20 to 22 per cent of its total debt.

However, at this juncture no large-scale currency movements are expected to take place as the dollar still remains the reserve currency since there is no other alternative currency that can replace it.

The Euro zone is confronted with its own sovereign debt crisis and Japan has been severely impacted by the tsunami. The Chinese yuan is not seen as an option either.

Though some funds may move to Swiss francs this is a small market and does not have the capacity of the US economy to absorb the huge quantity of liquidity.

Courtesy: Mail Today

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