Covid-19: Reserves to the rescue

  • Blog Post Date 11 April, 2020
  • Perspectives
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On 27 March 2020, the Government of India announced a relief package of Rs. 1.7 trillion to deal with the Covid-19 crisis and its possible adverse effects on the economy. A view put forth by critics is that the Fiscal Responsibility and Budget Management Act should be suspended so that a larger package can be financed. In this post, Gurbachan Singh discusses how the Act can be suspended and a higher fiscal deficit incurred in a prudent way.

On 27 March 2020, the Government of India (GOI) announced a relief package of Rs. 1.7 trillion to deal with the Covid-19 crisis and its possible adverse effects on the economy. However, many economists and others have criticised this. So, why did the GOI stop at a relief package of just Rs. 1.7 trillion? One reason can be that a higher government spending will lead to a larger fiscal deficit that will violate the Fiscal Responsibility and Budget Management (FRBM) Act, 2003. So, should we suspend the FRBM Act?

If we suspend the FRBM Act without keeping in mind where we do have resources and where we do not, then there can be implications for macro-financial stability. We may run into a fiscal crisis at some stage (see, for example, Romer (2012), section 12.10). So, what can we do?

Using what we have

It is well-accepted that in good times, we should not get complacent and compromise on building safeguards for a rainy day. But it is also imperative that in an emergency, we should not hesitate to use whatever safeguards we have built up in the good times. Given this principle, it is important that we reconsider what we have. In what follows, I will focus on the economics involved and abstract from the legal and administrative aspects.

It is fortuitous that at present the Reserve Bank of India (RBI) holds US$469.9 billion of foreign exchange reserves (hereafter, reserves) as on 20 March 2020; this is about Rs. 35 trillion. Let us put this number in context; the relief package of Rs 1.7 trillion that the GOI has announced is only about 5% of the reserves. So, the reserves are quite large (more on this later). If the RBI were to reduce the reserves by even 10% (though there is, in my view, scope for even larger reduction), we are talking about the possibility of an additional relief package twice the size of the existing relief package!

The use of reserves is typically considered in the context of an actual or a potential currency crisis but that need not always be so. We do not have a currency crisis at present.1 However, we do have a Covid-19 crisis on hand, and there is a broader purpose which reserves can serve – more so when the idea is to suspend the FRBM Act in the best way possible.

Open economy in a crisis situation

There are reasons to believe that the number of patients suffering from Covid-19 who will need treatment will jump in a big way in the near future. There is a need then to increase the supplies of various things like gloves, personal protection equipment, Hazmat suits, body overalls, goggles, N-95 masks, ventilators, etc., and make them widely available to nurses, doctors and health workers. The medical infrastructure in the country is inadequate even in normal times; in an abnormal situation, it can show up serious weaknesses. So, it needs to be improved and expanded quickly and substantially. We need more makeshift hospitals, wards to isolate many patients, testing labs, and quarantine facilities.

Medical supplies are one important part of the story. But there can be other goods and services that India may need at this hour. However, there are supply constraints within the economy in the short run. But imports can help in a big way at this juncture. As mentioned earlier, fortuitously, India has excessive foreign exchange reserves at this juncture, and these can be used to finance the additional imports bill.

It is true that some imports have become difficult at a time like this – more so when it comes to medical supplies when other countries need these for their own citizens. However, there are countries like China that have already dealt with much of the problem and that are returning to normal production and exports. There are also firms in different countries that are able and willing to supply some, if not all, of all that is required.

Are excess foreign exchange reserves a reality?

On 8 September 2017, the reserves crossed the US$400 billion mark in India. At the time, I had shown how the reserves were large relative to the needs of the economy (Singh 2017). Now they are even larger (even after considering some growth in the meanwhile). In what sense exactly are the reserves excessive in India? It is important to reiterate the arguments briefly here.

Unlike 1966 and 1991 (on both occasions India had a currency crisis), we now have a regime of flexible exchange rates. So, we have an adjustment mechanism to take care of a possible rise in current account deficits that may arise now and then; this avoids a currency crisis due to the current account deficits. So, this obviates the need to hold huge reserves.

It is true that flexibility in exchange rates can easily give way to volatility (as was the case to some extent in 2013 in India). In such a case, there can be a need for intervention by the public authorities. However, we now also have inflation targeting as a policy regime in place at the RBI (since 2016). This provides an anchor on not just inflation but also by implication on excessive depreciation of the rupee. So, there is a much less chance for exchange rates to get too volatile. Again, this obviates the need to hold huge reserves.

Even so, there can be volatile exchange rates due to very unstable international capital flows. This can indeed require intervention. However, the Centre signed a bilateral currency swap agreement with Japan for US$75 billion in 2018. Such facilities also reduce the need for very large reserves (see Singh 2014 for related issues).

It is only after the policy regime of flexible exchange rates, inflation targeting, and international currency swap arrangements (or credit lines) is found wanting that there can be a need for reserves. It is in this context that the reserves of US$469 billion are large (for more on this, see Singh 2017 and the references therein).2

In fact, the size of reserves can be brought down further by putting in place a regime of Pigouvian taxes3, which can be invoked any time there are sudden and large capital flows, which can cause externalities for the rest of the economy (Jeanne and Korinek 2010). With such policy of Pigouvian taxes in place, the need for reserves can be further reduced. But even now, we have good enough safeguards that make the size of the current level of reserves highly questionable.


The critics of the relief package announced by the GOI have simply stated that the FRBM Act should be suspended so that a larger package can be financed. But they have not considered the possible adverse implications of suspending the FRBM Act now or at a later stage. This post has discussed how the Act can be suspended and a higher fiscal deficit incurred in a prudent way.


  1. The rupee fell from Rs. 72.172 to Rs. 75.368 per US$ in March 2020 but that was nowhere near a currency crisis.

  2. The costs of reserves are estimated anywhere between 0.25% (Yeyati and Gómez 2019) and 1% of GDP (gross domestic product) (Rodrik 2006) every year. While this is a significant cost, it is true that it may still need to be incurred if there is no alternative to holding large reserves. However, that is simply not true at least in India in recent years; we do have other safeguards.

  3. A Pigouvian tax is a tax levied on any market activity that generates negative externalities (costs not internalised in the market price). The tax is intended to correct an inefficient market outcome, and does so by being set equal to the social cost of the negative externalities.

Further Reading


By: Gurbachan Singh

I thank Professor Partha Sen for the comments. These are very welcome. My response is as follows. Alongside an aggregated view, we also need to look at the disaggregated picture. If a country has been having a deficit on its current account, then the net holding of foreign assets for the country has a whole is negative. However, at the disaggregated level, there can be some (or even many) firms or institutions which have, at their own level, a net positive holding of assets in the rest of the world. Such firms or institutions do own assets abroad – notwithstanding the fact that the country as a whole has a net negative position with regard to assets in the rest of the world. In this context, the RBI very much owns the foreign exchange reserves that it has. More generally speaking, the RBI has assets that include foreign assets and domestic assets. It has to take a portfolio decision on how much of domestic assets (typically government securities) and how much of foreign exchange reserves (more generally, foreign assets) that it would like to hold. The net position on assets with the rest of the world is conceptually an issue separate from the question of portfolio choice for the central bank. The portfolio choice of assets is not the same for all central banks. Nor is it the same for a given central bank over time. The portfolio choice of the central bank depends on the broader macroeconomic policy regime in place. As I wrote in the article, if the policy regime includes (a) flexible exchange rates, (b) inflation targeting, and (c) currency swap arrangement with the rest of the world, then the need for foreign exchange reserves is not very large. This is the situation in India now after a series of policy changes that have been happening over very many years. If the public authorities do decide to cut down reserves (and I hope that they do at this juncture when we have Covid-19 crisis and the need to mobilise resources), they can, to begin with, do so in a small way. But even a 10% cut in reserves is a huge amount. For even greater comfort, alongside the possible policy of cutting down some reserves, the public authorities can put in place a policy of Pigouvian tax that may be imposed, in a calibrated way, on sudden and large international capital flows as a way to correct for the negative externalities that such flows can cause on the real sector (Jeanne and Korinek 2010). Then the need for holding large reserves becomes even less (and the cost of possible negative externalities will be borne also by the FIIs). Thank you very much again. Gurbachan Singh

By: Partha Sen

Dr Gurbachan Singh argues that India could use some of its foreign exchange reserves to pay for Covid-19 expenditure, because the reserves are "excessive". I disagree with his analysis. Foreign exchange reserves can be accumulated by running current account surpluses (i.e. keeping national expenditure below GNP). But India's foreign exchange reserves are a result of sterilized intervention. India has not run a current account surplus since year dot (almost). There have been massive capital inflows--capital account of BOP. The RBI buys foreign currency. This would increase the money supply. So it "sterilizes" the money stock by conducting a ("contractionary") open market operation. Net result: RBI's foreign assets up, liabilities government bonds up by the same amount. When a capital outflows takes place, ceteris paribus, both assets and liabilities decrease. Now the RBI does not own these foreign reserves, so using these is problematic. Think of an individual who has "money" by being thrifty. He/She can literally burn this. But not true of an individual who borrows "money". There will be a payback time. Partha Sen

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