Dr Reddy’s warning: India vulnerable to crude price volatility

The Reserve Bank of India Governor, Dr Y V Reddy, is against the setting up of a stabilisation fund.

The Reserve Bank of India (RBI) Governor, Dr Y V Reddy, is against the setting up of a stabilisation fund. “There is no serious consideration of setting up a stabilisation or sovereign wealth fund,” Reddy said while addressing the Foreign Exchange Dealers Association of India (FEDAI) here. He added that the country is “vulnerable” to shocks arising out of volatility in global oil prices. India imports 73 per cent of oil to meet its fuel needs and faces inflationary pressures on any sharp increase in global crude prices. Crude oil touched a record level of $83 a barrel on September 20. In India, Inflation rose to 3.42 per cent for the week ended September 22, compared to 3.23 per cent in the previous week.

The stabilisation fund comprises windfalls generated through commodity exports like edible oil while the sovereign wealth fund could be carved out from a part of forex reserves to invest in high-yielding assets. “If and when we decide to set up these funds, we have to put in place measures of governance, transparency and accountability which would provide the necessary comfort,” the RBI governor explained.

Of late, there have been suggestions that India should consider setting up a wealth fund on the lines of either a stabilisation fund or a SWF. “As mentioned, the objectives of establishing stabilisation funds are mainly to smoothen the revenue flows arising out of volatility in commodity export proceeds. India’s export basket is diversified and does not have a dominant ‘exportable’ natural resource that might bring ‘windfall’ gains.”

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Further, the country has experienced consistent current account deficits, barring a modest surplus for a few years. Hence, creating a stabilisation fund may not be justified on the basis of the current situation. SWFs are generally created amidst current account surpluses when foreign exchange reserves attain a level higher than that perceived as ‘adequate’. “If we follow this global experience, consideration of an SWF for India may ideally await a ‘more comfortable current account’ and ‘significantly improved fiscal’ scene,” he said.

It is sometimes argued that in the context of the significant growth of foreign exchange reserves in recent years, the portion of reserves that is in excess of a certain recommended level may be carved out and invested separately to maximise returns, the RBI governor said.

“In this regard, it is necessary to view the concept of ‘excess reserves’ from several angles, including from the perspective of possible real sector shocks to the current account and the nature of capital flows,” Reddy concluded in his address.