We have traveled from a very precarious position of defaulting on our external payment obligations to a most solvent position among the emerging economies: The foreign exchange reserves rose from a miniscule $5.83 bn as on March 1991 to $118 bn by April 30, 2004. What a transformation! The forex reserves have grown by $16 bn during the first four months of 2004. Indeed, the flow of dollars has been so massive in the recent past that in a single week the dollar accretion is reported to have been $3.70 bn. But the moot question is "why anxiety at mounting accretions?" and that is what this article examines.

In the recent past, the country has been experiencing large forex inflows. Reserve Bank of India (RBI) attributes such accretion to three factors: Booming software export revenues and remittances from the Indian workers abroad; timely repatriation of export earnings and strong inflows of both foreign direct and institutional investments (Table 1). In addition to these factors, arbitrage activity by the foreign investors to take advantage of the interest differential between the countries is pouring a lot of money into the Indian market. This has obviously led to dramatic increase in the foreign exchange reserves.

The accumulated foreign exchange reserves reflects RBI's policy of maintaining an adequate level of foreign exchange reserves that are expected to generate confidence in its monetary and exchange rate policies; enhance its scope to intervene in the forex markets; contain external vulnerability; provide confidence to the market; and embolden market participants. True, such accretion of reserves was indeed an `insurance' till 2002 but according to many fundamentalists, the current level of reserves seems to be more than adequate and hence they argue that such reserves involve an opportunity cost. As per the annual report of RBI for 2002-03, RBI earned a paltry 3.1% return on the forex reserves managed by it vis-à-vis 5.10% that could have been earned from a 10-year government bond and that is the opportunity cost the country is paying for maintaining forex reserves. Indeed RBI sustained a loss of Rs.1500 cr by way of opportunity cost during 2002-03 and to that extent the dividend payout to government has come down.

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