With around $312 billion foreign exchange (forex) reserves, India’s bank balance is quite healthy. But the country seems to be paying a heavy price while accumulating excess foreign exchange reserves — or what’s called reserve hoarding.

A study by Abhijit Sen Gupta for economic think tank Indian Council of Research in International Economic Relations (ICRIER) says the country is losing more than 2 per cent of its gross domestic product (GDP) by accumulating reserves instead of employing resources to increase the physical capital of the economy. By diverting resources from physical investment and employing them for reserve accumulation, India lost nearly $13 billion, or 2.34 per cent, of its GDP in 2003-04.

In the following two years the loss was slightly lower due to a higher return on foreign currency assets. However, with a relatively low incremental capital-output ratio (ICOR) and hence a high marginal product of capital in 2006-07, the loss rose drastically to nearly $18 billion, or 2.16per cent, of GDP. “Thus, we find that in terms of physical investment foregone, India is paying a substantial cost,” the study said.

The cost of excess reserves has been increasing steadily and in 2006-07 stood in excess of $2.5 billion, or 0.30 per cent, of the GDP. The study makes three interesting observations: India has accumulated excess reserves, the cost of excess reserves and how returns can be maximised.

“By 2007 India had accumulated more than $80 billion of excess reserves,” says the study — Cost of holding excess reserves: The Indian experience. The cost of holding reserves is measured by the interest rate spread between the private sector’s cost of short-term borrowing abroad and the yield that

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