RISING FOREIGN EXCHANGE RESERVES: A POTENTIAL SOURCE FOR INFRASTRUCTURAL DEVELOPMENT IN INDIA? JINA SAHA1 TARUMOY CHAUDHUR 2I ABSTRACT Since the inception and execution of the New Economic Policy introduced by the GoI in 1991, the Indian economy has seen significant changes both in the domestic and the foreign front. There have been macroeconomic stabilizations within the country as well as new directions in foreign trade. In the past 16 years the world has seen India transform from a developing economy to an emerging economy. Along with China, it is being referred to as an Asian superpower. The past performance of a robust service industry, specially in the field of IT and ITeS, judicious fiscal and monetary policies in the home front and above all, prudential foreign policies have catapulted India to the second position in the list of the fastest growing economies of the world. This is in turn, shifting the global economic centre of gravity towards India. But much dust has also been put under the carpet. The term which is mostly used for infrastructure in the country is ?dismal?. This raises a major question- Will India?s growth momentum come to a halt in the long run, infrastructure being the main culprit? The infrastructure (both physical and human) is the backbone of a country. Although it is necessary for India to meet global standards if it wants more of foreign investments, little has been done about it. Instead of raising funds in the domestic sector through the introduction of taxes, surcharges and cesses for the cause, our argument is: Why can?t we utilize a part of the huge foreign reserves which we have amassed over the years? Studies show that the composition of our foreign reserves is quite comfortable. Even in times of dire necessities, we can still avoid situations like what the Asian Tigers have faced in late 1990s. The RBI?s maintenance of its policy of ?safety, liquidity and returns? (with respect to foreign reserves) will not be hampered if it lends a small portion to the real sector in the domestic economy. We can learn from the procedures followed by other Asian economies and modify them to meet our needs. Or we can formulate our own policies conducive to our environment. Infrastructure development will have both upstream and downstream effects and that is sure to wipe off that nagging question: Can India continue? INTRODUCTION Over the last 60 years, India's foreign trade has undergone a complete change in terms of composition and direction. Foreign trade of India suffered from strict bureaucratic and discretionary controls during 1950-1990. Foreign exchange transactions were tightly controlled by the government and the RBI. During this period, India, with some exceptions, always faced deficit in its balance of payments. This was characteristic of a developing country struggling for reconstruction and modernization of its economy. Imports galloped because of increasing requirements of capital goods, defence equipment, petroleum products, and raw materials. Exports remained relatively sluggish 1 Faculty, Vishwashanti Gurukul, Pune. 2 Student, National Law University, Jodhpur Electronic copy available at: http://ssrn.com/abstract=1266716 owing to lack of exportable surplus, competition in the international market, inflation at home, and increasing protectionist policies of the developed countries. Beginning mid-1991, the government of India introduced a series of reforms to liberalize the economy. Reforms in the external sector of India were intended to integrate the Indian economy with the world economy. The level of foreign exchange reserves has increased from US$ 5.8 billion as at end-March 1991 to US$ 165.3 billion as at end- September 2006. High foreign exchange reserves are often seen as an indicator of a strong currency. A strong currency, subsequently, means stronger confidence in the target nation for global investors. But what if the confidence is quickly evaporated because of innumerable hurdles posed by an abysmal infrastructural scenario? Can India, then, continue to ?shine? at a remarkable growth rate it has achieved till now? Studies reveal that to maintain an 8% growth rate, infrastructure will have to maintain a 9% growth rate. The World Bank recently rated India 134th in the world (out of 175) for ease of doing business. This paper attempts to find out the viabilities of combining the two sectors of the economy and look for a win-win situation - utilizing a part of foreign reserves to develop the ailing infrastructural area so that in the long run, more foreign reserves are built up through more investments riding piggy back on high investor confidence. GROWTH AND COMPOSITION OF FOREIGN EXCHANGE After independence, till the early years of the 90s, India was a closed economy ? import quotas for virtually every commodity loomed large, and wherever there weren?t, average tariffs was more than 200%, and there were stringent restrictions on foreign investment. Due to dwindling forex reserves in 1991 and the imminent threat the situation posed for the country consequently, the country had to follow a liberalized regime on the foreign sector front since 1991. And then there was no looking back. India?s foreign exchange reserves have increased substantially in the past few years and are now among one of the largest in the world (Fig. 1 3) . The trade to GDP ratio has increased from 15 percent to 35 percent of GDP between 1990 and 2005. All these indicate towards the increasing competitiveness of the Indian economy and strong confidence of the global community in India?s growth potential. For the first time after 1 According to the triennial central bank survey conducted by the Bank for International Settlements (BIS), India is among the fastest growing foreign exchange markets in terms of turnover. Electronic copy available at: http://ssrn.com/abstract=1266716 our independence the balance of payments issue can be placed somewhat, in the back burner. It is noted that the rate of growth has been increasing mainly since 2002. This may be due to the fact that forex reserves data prior to 2002-03 do not include the Reserve Tranche Position (RTP) component in IMF. Fig. 1 Movements in Foreign Exchange reserves (Mar01-Mar06 4) Source: Official website of Reserve Bank of India (www.rbi.org.in ) The current account balance which showed a deficit at 3.1 per cent of GDP in 1990- 91 turned into a surplus of 0.7 per cent in 2002-03. The inflow of dollars due to an impressive show by the invisible account resulted in a surplus of US $ 14.1 billion in the current account during 2003-04. However, the picture turned gray during 2004-05, with the current account showing a deficit of US$ 2.5 billion, the sudden surge in oil prices in international markets being responsible for this. The first half of 2006-07 depicted a current account deficit of US$ 11.7 billion 5 . The composition of foreign exchange reserves show that the accumulation has been mainly on three fronts (Fig 2): ? Foreign investment ( directly as FDIs/ indirectly as portfolio investments or FIIs) ? External commercial borrowings 4 http://rbi.org.in/scripts/PublicationsView.aspx?id=9234 (visited on January 19, 2008). 5 Report on Foreign Exchange Reserves (2006-07), Covering period up to September 2006, http://rbi.org.in/scripts/PublicationsView.aspx?id=9234 (visited on January 20, 2008). ? Banking capital (of which NRI deposits account for a high percent) Fig. 2 Sources of Accretion to Foreign Exchange Reserves since 19916 Source: Official website of Reserve Bank of India (www.rbi.org.in ) As is evident, this increase in forex reserves has been brought about mainly by a substantial increase in foreign investments. Foreign direct investments (FDIs) were to the tune of US$ 7.8 billion in 2005-06 up from US $ 129 million in 1991-92. Foreign Institutional Investments (FIIs), which commenced in January 1993, have also shown significant increase over the subsequent years. Cumulative net FII investments shot up from US$ 827 million (end-December 1993) to US$ 46.9 billion (end-September 2006). Outstanding NRI deposits increased from US$ 13.7 billion at end-March 1991 to US$ 36.6 billion at September 20067. REVIEW OF FOREIGN INVESTMENTS GROWTH IN INDIA 6 Supra note 2. 7Report on Foreign Exchange Reserves (2006-07), Covering period up to September 2006- Published by RBI Foreign investments have been to the tune of US $ 99.6 billion (from 91-92 to Sep 06), thus placing it in the numero uno position as a source of foreign reserves (ref. Fig 2). A further year-on-year (Mar 04-Mar 07) breakup is shown in Fig 3. India has proved to be a favourite destination for foreign investments. Apart from attractive interest rates, this is also because the country has liberal and more or less transparent policies on FDI while considering the emerging economies. FDI up to 100% is allowed under the automatic route in all activities/sectors except some restricted areas where it needs government approval. (The policies are formulated by the Department of Industrial Policy and Promotion (DIPP) in the Ministry of Commerce and Industry. The Foreign Investment Promotion Board (FIPB) in the Ministry of Finance is responsible for granting approval for FDI in sectors/activities where prior government approval is required). Another component of foreign investment is the FII. Let us have a small discussion on both these types of foreign investments. FDI for a country will be the acquisition of physical assets in the domestic economy by foreign companies, with operations and control residing in the parent corporation abroad. It brings along with it finance, modern technology and an export market for the destination country. The impact of FDI in India is bound to be considerable, mainly because it would primarily involve setting up of production bases ? firms, power plants, communication networks, etc.- all generating direct employment. There is also a multiplier effect because of further investments (both domestic and foreign) in downstream and upstream projects thereof. However, the cons are that the domestic entrepreneur feels the heat having to compete with the huge foreign conglomerates. FDI policies should therefore ensure at least a minimum level of local roles, export commitment and technology transfer from the foreign companies. FII too provides large chunks of much needed capital, but indirectly. The indirect benefits to the country include revamping local practices to meet international standards in areas of trading, risk management, new financial instruments research etc., thus facilitating markets to become deeper and more liquid, resulting in a better allocation of capital among globally competitive sectors of the economy. Though these portfolio flows can technically reverse at any time, this risk is not very high as long as the host country follows sensible economic policies. India has typically depended more on FII than FDI. Fig 3 International Investment Position of India (US $ billion) March 04 March 05 March 06 March 07 R PR PR P A. Assets 136.0 166.8 182.8 243.6 (21.3) (23.3) (22.9) (25.7) 1. Direct Investment 7.8 10.0 13.0 24.0 2. Portfolio Investment 0.4 0.5 1.0 0.8 2.1 Equity Securities 0.2 0.3 0.5 0.4 2.2 Debt securities 0.2 0.2 0.5 0.4 3. Other Investment 14.9 14.8 17.2 19.7 3.1 Trade Credits 0.5 1.1 -0.3 2.5 3.2 Loans 1.8 1.9 2.6 2.6 3.3 Currency and Deposits 9.5 8.4 11.6 10.3 3.4 Other Assets 3.1 3.4 3.3 4.2 4. Reserve Assets 113.0 141.5 151.6 199.2 (17.7) (19.8) (19.0) (21.0) B. Liabilities 183.2 209.8 230.8 288.9 (29.0) (29.4) (28.9) (30.5) 1. Direct Investment 38.2 44.5 51.1 72.3 (6.0) (6.2) (6.4) (7.6) 2. Portfolio Investment 43.7 55.7 64.6 80.3 (6.9) (7.8) (8.1) (8.5) 2.1 Equity Securities 33.9 43.2 54.7 63.3 2.2 Debt securities 9.8 12.5 9.9 17.0 3. Other Investment 101.3 109.7 115.0 136.4 (16.1) (15.4) (14.4) (14.4) 3.1 Trade Credits 6.3 9.6 10.5 13.7 3.2 Loans 61.9 65.3 67.8 81.1 3.3 Currency and Deposits 32.2 33.6 36.2 40.7 3.4 Other Liabilities 1.0 1.2 0.6 0.9 C. Net Position (A-B) -47.2 -43.0 -48.0 -45.3 (-7.6) (-6.0) (-6.0) (-4.8) R: Revised. PR: Partially Revised. P: Provisional. Note: Figures in parentheses represent percentage to GDP Source: Official website of Reserve Bank of India (www.rbi.org.in ) According to the data released by the SEBI, investors have invested US $ 15.1 billion as FII in the Indian stock markets during 2007-08 (up to October 19, 2007) as compared to net purchases of US $ 2.2 billion during the corresponding period of the previous year. The number of foreign institutional investors registered with the SEBI increased from 997 by end-March 2007 to 1,113 by October 15, 2007. Apart from the well known IT, BPO and KPO sectors, unexplored service sectors like medical care are potential sectors for foreign investment. Investing in the secondary sector/manufacturing sector is a brick and mortar investment. It makes provision for employment to semi skilled and skilled labor. India?s burgeoning tertiary sector requires fewer but highly skilled workers. Hence, more investments in both the areas are needed, be it in the form of FDI or FII. Apart from the existing policies, foreign companies will yet need reassurances in many areas to make them ready to invest in India. One of the crucial questions here is: Will India make its capital account fully convertible? If the answer is in the affirmative, the next question arises - When? CAPITAL FLOWS AND CAC ?A fundamental change that has taken place in recent years is the importance of capital flows in determining exchange rate movements as against trade deficits and economic growth, which were important in the earlier days. The latter do matter, but only over a period of time. Capital flows, on the other hand, have become the primary determinants of exchange rate movements on a day-to-day basis. Secondly, unlike trade flows, capital flows in "gross" terms which affect exchange rate can be several times higher than "net" flows on any day.?8 If capital flows are so important, shouldn?t India strive for an environment that allows greater flexibility in its capital market? Well, it has. In consultation with the Government of India, the Reserve Bank of India has appointed a committee to set out the framework for fuller Capital Account Convertibility. It will also provide Secretariat to the Commi 9ttee . The Tarapore Committee (2006) has proposed full Capital Account Convertibility (CAC) of the rupee. In simple language what this means is that it allows anyone to freely move from local currency into foreign currency and back. Of course, this is not without risks. The Asian Crisis in 1997-98 was due to domestic funds suddenly 8 Speech of Dr. Bimal Jalan, Governor, Reserve Bank of India delivered on the 14th August 2003, at the 14th National Assembly of Forex Association of India in Mumbai, http://www.banknetindia.com/banking/jalan2.htm (visited on January 22, 2008). 9 http://www.banknetindia.com/banking/convertible1.htm (visited on January 20, 2008). ?flying out? of the economies (and getting transformed to foreign funds) due to an external credit crunch. But that was because the external debts of these economies formed a large part of their foreign reserves. Very fortunately, by following prudential and cautious rules and regulations, this has not been the case with India. Domestic interest rates have come down substantially in the past few years. Still, caution should be taken; they are higher than those prevailing in other developed and emerging economies (Fig 4). This provides an "arbitrage" opportunity to holder of liquid assets abroad: people may take advantage of higher interest rates in India leading to a short-term upsurge in capital flows. However, there are several considerations, which indicate that this is unlikely to be an important factor in influencing remittances or investment decisions by NRIs or foreign entities. The minimum period of deposits by NRIs in Indian rupees is one year, and the interest rate there is subject to a ceiling rate of 2.5 per cent over Libor. Investments by FIIs in debt funds are subject to an overall cap of $ 1 billion in the aggregate. Thus, the possibility of arbitrage by FIIs in this area is limited to this low figure of $ 1 billion. The ?adequacy requirements? as proposed by the Guidotti-Greenspan formula as well as ?Liquidity at risk? criteria, both of which are internationally accepted measures regarding foreign reserves vulnerability, suggests that India holds a comfortable composition of foreign reserves and can withstand shocks from outside, unless they are exceptionally devastating. Fig 4 Short-term Interest Rates (Per cent) March 2006 March 2007 June 2007 September 2007 October 2007* Advanced Economies Euro Area 2.80 3.91 4.16 4.73 4.66 Japan 0.04 0.57 0.63 0.73 0.73 UK 4.58 5.55 5.92 6.28 6.25 US 4.77 5.23 5.27 4.72 4.72 Emerging Market Economies Brazil 16.54 12.68 11.93 11.18 11.18 China 2.40 2.86 3.08 3.86 3.87 India 6.11 7.98 7.39 7.19 7.10 Singapore 3.44 3.00 2.55 2.56 2.50 South Korea 4.26 4.94 5.03 5.34 5.34 Thailand 5.10 4.45 3.75 3.55 3.55 *: As on October 17, 2007. Source: The Economist One way to contain risks is to increase the holdings of gold. The gold?s share of reserves was just above 10 per cent in 2006 at around 357 tonnes. This is less than the average holding of developed countries. Gold does not earn any interest, other than the return that it fetches on lendings. But it does form a dependable back up in times of crises. Having looked long at the external sector, let us now turn towards the domestic side in the area of infrastructure. INFRASTRUCTURE IN INDIA The index of industrial production (IIP) rose by 9.8 per cent during April-August 2007 as against 11.0 per cent in the corresponding period last year. Manufacturing output increased by 10.3 per cent while mining activity and electricity generation rose by 5.4 per cent and 8.3 per cent, respectively10. The growth rates, seemingly impressive, have shown decelerated growth while comparing with the figures of the previous year (Fig 5). Services sector, on the other hand has shown much better performance. It continued to record double-digit growth (10.6 per cent in April-June 2007 above 11.6 per cent in Fig 511 10 Mid-Term Review of Annual Policy Statement for the Year 2007-08, Reserve Bank of India, http://rbi.org.in/scripts/AnnualPublications.aspx?head=Macroeconomic%20and%20Monetary%20Develop ments, visited on January 29, 2008. 11 http://www.rbi.org.in/scripts/PublicationsView.aspx?id=9802, visited on January 24, 2008. April-June 2006), driving the growth momentum of the economy. The sector continued to be led by the sub-sectors ?trade, hotel, transport and communication 12? . This phenomenon, often referred to as ?deindustrialization? by economists is not peculiar to India. Any country which is facing high growth rate will tend to shift from the secondary sector of manufacturing to the tertiary sector of services. However, it will be wrong to assume that manufacturing sector has lost its importance in India. Rather, the economic conditions require that both manufacturing (especially the small scale industries) and services sector face robust growth in order to sustain the position of the second fastest growing economy in the world. All this requires that the infrastructural conditions of the country act as a facilitator to help both the sectors grow. According to the GOI, India would need approximately $ 320 billion investment (at 2005/06 prices) in various infrastructure sectors during ongoing the Eleventh Five-Year Plan. The sector-wise requirements of funds for sectors are given in Fig 6. The discussions here, however, go beyond physical infrastructure. Keeping in mind the huge importance of human infrastructure for a country to sustain long term growth, the discussion is extended to the arena of education and health too. Let us now proceed to have a glimpse of each sector. Fig 6 Current Overall Target and its Composition (at 2005/06 prices) 12 Reports from the RBI Residual Sectors include telecom, SEZs, supporting urban infrastructure, water and sanitation, state and rural roads, logistics, pipelines etc. Roads India has the second largest road network in the world with a total network of 3.3 million km. The figures do not seem very impressive though, once a look at the conditions of the National Highways, the so-called arteries of India. Roads occupy a crucial position in the transportation matrix of India (they carry nearly 65 per cent of 13 freight and 85 per cent of passenger traffic). With proposals like the Golden Quadrilateral and the East-West corridor, this area can prove to be the main driver of infrastructural development. But the pace at which the work is progressing does not show a very rosy picture. Railways The average speed of an intermodal (container-carrying) train in India is 25kph, against 60kph in many o 14ther countries. Earlier being one of the premiers among loss making public sector units in India, it has recently shown some improvements in terms getting positive returns under Railway minister Lalu Prasad Yadav. Nonetheless, it has a long, long way to travel before it can even come to the standards of other developing 13 http://www.mapsofindia.com/infrastructure (visited on January 20, 2008) 14 Robert Wright, Railways: Slow journey to reform, http://www.ft.com/cms/s/2/639666e0-fd57-11db- 8d62-000b5df10621,dwp_uuid=d96e2c9a-f965-11db-9b6b-000b5df10621.html (visited on January 23, 2008). economies. Ironically, it remains far more firmly closed to outsiders than any other parts of the country?s transport infrastructure. Aviation ?You have the peculiar problem where the infrastructure on the ground is not fully in place but the infrastructure in the air is there in terms of flights,? says KV K 5amath, chief executive officer of ICICI Bank 1. Where most countries now bustle with large, ultra-modern airports with duty-free shops, cafés and luxury-goods stores even in Asia, India?s airports are nowhere in the picture. Many do not have the most basic facilities, such as adequate parking. India?s major airports are also overloaded - analysts estimate that during peak passenger traffic hours, New Delhi and Mumbai international airports operate at about 20-25 per cent overcapacity. This is in spite of Indians making just 0.02 flights per head per year against 0.09 in China and 2.2 in the US. Hospitality India?s tourism industry is expected to grow 8 per cent annually between 2007 and 2016, according to the World Travel and Tourism Council. But the conditions prevailing do not show healthy signs to embrace this growth. At the end of 2004 there were fewer than 100,000 hotel rooms, 31 per cent of which were in Delhi, Mumbai, Chennai and Bangalore. Hilton Hotels announced a JV with Indian developer DLF to build and own 75 hotels and serviced apartments over the next seven years starting November 2006 16. Investors are also showing keen interest in economy hotels. Warburg Pincus made its entry into the hotel sector with a $62m investment in Lemon Tree, a new chain of mid-priced properties. However, soaring real- estate prices pose as an entry barrier. This is one of the main reasons why hoteliers have been building lucrative luxury hotels rather than the much-needed economy ones. Power 15 Joe Leahy, Aviation: Airports trail behind high-flying irlines,http://www.ft.com/cms/s/2/5ec80740-fd57- 11db-8d62-000b5df10621,dwp_uuid=d96e2c9a-f965-11db-9b6b-000b5df10621.html (visited on January 23, 2008). 16 Amy Yee, Hotels: Shortage paves way for a beds boom, http://www.ft.com/cms/s/2/60d9d356-fd57-11db- 8d62-000b5df10621,dwp_uuid=d96e2c9a-f965-11db-9b6b-000b5df10621.html (visited on January 23, 2008). The planning commission projects that the country will need to raise generating capacity to 778,000 megawatts by 2032 from 127,400MW at present to maintain 8 per cent annual economic growth. As industries expand and rising incomes of consumers create greater demand, energy consumption will obviously grow. With around a quarter of India?s population in rural areas ? much of which is without electricity ? per capita energy consumption was just 594 kilowatts in 2003, according to UNDP, against 14,057 kW in th 17e US. But even with such relatively low energy consumption, the country faces chronic power shortages. Demand for electricity in India exceeded supply by 7.3 per cent in 2005, said the Central Electricity Authority. The regulatory environment poses a particular challenge for foreign companies. Plants largely risk running aground because of the basic lack of fuel to run them. Because of shortage of natural gas in the country, even existing gas-based stations are generating only 60 per cent of capacity. And domestic coal supplies cannot keep pace with demand. Ports The occurrence of demand outstripping capacity is a common feature in this sector too. Some of the most old-fashioned, inefficient facilities are those (the port of Kolkata, for example) where the private sector remains excluded. This results in India?s exports and imports being burdened with higher costs. Each ship at Jawaharlal Nehru Port (Mumbai) on a given day can carry a maximum of only 2,500 TEUs (twenty equivalent units) of containers, as against at least 12,000 for the largest ships at Chinese po 18rts. The vessels serving Indian ports not only have higher costs but also are too small to make intercontinental voyages. So containers bound for Europe/North America must be trans-shipped at ports such as Colombo or Salalah (Oman) ? all at extra cost. Telecommunications Tele-penetration in India grew from 0.2 per cent in 1947 to 2 per cent in 1998. The reforms of the telecoms industry the following year since then has lead to a huge jump in growth. The number of mobile phone subscribers is growing exponentially and 17 Amy Yee, Power: Switching on to progress, http://www.ft.com/cms/s/2/62e712e4-fd57-11db-8d62- 000b5df10621,dwp_uuid=d96e2c9a-f965-11db-9b6b-000b5df10621.html (visited on January 23, 2008). 18 Robert Wright, Shipping: Ports await shipment of fresh investment, http://www.ft.com/cms/s/2/623849b2-fd57-11db-8d62-000b5df10621,dwp_uuid=d96e2c9a-f965-11db- 9b6b-000b5df10621.html (visited on January 23, 2008). India has overtaken China to become the fastest-growing mobile market in the world. The country now has more than 200m phone subscribers. To sustain this growth, operators are striving to reach into rural areas where penetration is as low as 2 per cent compared with 40 to 50 per cent in big 19 cities . However, this is easier said than done. These areas are often inaccessible because of poor roads and limited electricity. Crude roads and shaky bridges can be washed away in torrential rains. Lack of electricity makes it a huge challenge to run telecom equipment in phone towers. Education The PROBE survey (1999) painstakingly documents the inadequacy of school infrastructure in India. Basic facilities including furniture, blackboards, toilets, playgrounds, and even teaching aids are not found in many public schools. Although there has been a continuous growth in the number of schools established at the primary level, (India has the second largest education system in the world. Between 1950?1 and 2002?3, the number of primary schools increased nearly three times in India, from 209 0,671 to 651,382 2) it has increased only physical access to schools. The low quality of education provided remains a critical issue in India?s educational system where even those children who have completed five years of primary schooling may not be functionally literate and numerate. Thus, the fact remains that the literacy rate figures for the country may not necessarily translate into effective literacy (and numeracy) in the population. Health According to the Human Development Report 2001 of the UNDP, India ranks among the last few countries in terms of general human dev 21elopment indicators. Of the many measures that showed India?s poor status, health indicators were among the lowest. These figures are reflections of the high poverty levels and a climate conducive to the multiplication of disease agents. Infant mortality rate, life expectancy, malnutrition and the prevalence of deadly diseases and immunization levels are key indicators of health 19 Amy Yee, Telecommunications: Success story faces the rural challenge, http://www.ft.com/cms/s/2/65a86eba-fd57-11db-8d62-000b5df10621,dwp_uuid=d96e2c9a-f965-11db- 9b6b-000b5df10621.html (visited on January 23, 2008) 20 Laveesh Bhandari, Social Infrastructure: Urban Health and Education, http://www.3inetwork.org/reports/IIR2006/Social_Infra.pdf (visited on January 23, 2008). 21 Ibid. status of a country. India?s position has been pathetic in all these areas. Between 1961 and 1998 in urban areas the number of hospitals has increased, but there hasn?t been a corresponding increase in the number of beds and dispensaries. In quantity terms, the size of the health infrastructure is not insignificant but its distribution is lopsided. For instance, there is one qualified doctor for 802 people and one hospital for 11,744 people, besides one bed for 693 people in the country 22 . THE CASE FOR LENDING PART OF FOREIGN RESERVES TO THE DOMESTIC INFRASTRUCTURAL SECTOR Having a look at both the foreign reserves and the infrastructural conditions in India, (though for want of space, many areas still remain out of discussions) does it seem that a case for diverting some of the foreign reserves towards the domestic sector is very unrealistic? The Deepak Parekh Committee (2007) which was set up for drawing comprehensive plans for Indian infrastructure also puts forward this suggestion among its many other recommendations: ?Meanwhile, India?s foreign exchange reserves continue to grow rapidly. These reserves, while providing a buffer against adverse external developments, do not contribute to the real sector, as they are invested in foreign currency assets such as government bonds. The financial return on these reserves is small. In fact, it is well known that the cost of sterilization that the reserve accumulation entails exceeds the return on these investments.?23 Finance Minister P. Chidambaram has asked the Reserve Bank of India to lend only $5 billion from its $212 billion kitty. The ECBs can be successfully diverted towards dedicated growth of infrastructure. The Chairman of ADB, in a recent interview24 stated that without private investment, including foreign players, India cannot meet its targeted growth rate in infrastructure and consequently, growth. Two key risks posed by opponents: The economy might face inflation because of additional domestic liquidity, and the country may lose hard-currency cover in the event of a run on the rupee. Do these arguments hold? 22 Central Bureau of Health Intelligence (2003) 23 http://www.pppinindia.com/pdf/deepak_parekh_report.pdf (visited on January 20, 2008) 24 Shantanu Nandan Sharma, TNN, ?India needs $800 bn for infrastructure in next 5 yrs?, http://economictimes.indiatimes.com/Interview/Rajat_M_Nag_Managing_Director_General_ADB/articles how/2607730.cms (visited on January 20, 2008). After four years of 8.5 percent compounded annual growth, the economy is exhausting its productive capacity. Whereas, there are serious supply constraints as is evident from the discussions in the previous section. BHE, India's biggest maker of power equipment, has a three-year order backlog. Pakistan's cement makers are hoping to benefit by investing in a situation where there is a shortage of building materials in India. Doesn?t all of this provide a perfect setting for spending a few billion dollars from foreign reserves to import turbines, railway coaches, port equipment and air-traffic control systems? We can always push reserves to play in the global market instead of holding them at low returns. The central bank is continuously buying dollars to stem the pace of appreciation in the rupee. However, it isn't making much dough on the assets it's acquiring with those dollars. In the year that ended June 2006, the Reserve Bank earned 3.9 percent on its reserves. Infrastructure promises significantly higher returns. NTPC sold a 10-year dollar-denominated bond last year, paying a coupon rate of about 5.9 percent. Investments in the area of education and health will reap long term benefits. The performance of the services sector is enviable to most countries of the world. And that performance is only half of the story that India is capable of. China is likely to rule in manufacturing sector; India must take advantage of the service industry. How will it be possible if the picture remains as it is? Moreover, we are talking about only a small portion of the total reserves. Many Asian countries including the likes of China, Singapore and South Korea have moved forward to allocate part of their reserves towards ?aggressively managed portfolios?. China has mobilized $200 billion of its foreign reserves towards its domestic economy. Even if India were to pay off its entire foreign borrowings, it would still be left with $44 billion. So a fifth of India's reserves are surplus. Out of this, the current proposal only envisages using $5 billion. How big a risk can that pose?