It has been a difficult year for the Indian economy. The country has been buffeted by falling growth, rising commodity prices, surging trade deficit, spiralling inflation, rising interest rates and plunging value of the Indian rupee.

Despite this crisis in the international and domestic economy, India's foreign exchange reserves have remained virtually unscathed.

While chaos and crisis prevailed all around, India's reserves rose by $6.7 billion during April-September 2011. Some of the principal foreign exchange inflows into the country were triggered by the very same weakness that afflicted the economy: surging inflation and spiralling interest rates.

As the cost of funds in the domestic economy surged and stock markets remained weak and ineffective source for funds, Indian companies turned to the international markets for capital requirements. Since the Indian economy remained one of the best performing markets in the world, Indian companies were able to mobilise funds at substantially low rates. The external commercial borrowing by Indian companies rose smartly by over 85 per cent from $5.7 billion to $10.6 billion during the first six months of the current fiscal.

FII inflows dwindle

Again, reflecting the weak global markets and growing risk aversion exhibited by international capital, foreign direct investments and portfolio investments into India although positive, presented a mixed bag. While international capital took recourse through the relatively safer foreign direct investments, inflows into the riskier capital markets dwindled.

Foreign direct investments into India grew by over 75 per cent while portfolio investments plunged by over 90 per cent. After the bullish trends exhibited by international capital at the end of 2010, caution seems to have become the catchword last year.

But the big boost to India's foreign exchange reserves came from increased flow into banking capital which grew by over 23 times. India's efforts to attract greater inflow of NRI deposits also seems to have paid rich dividends as it grew by over 72 per cent to $3.9 billion. As the apex bank pursued a tight money policy to contain inflation by consistent rate hikes, banks found it more prudent to attract NRI deposits. The NRIs became willing partners as they were able to get rates 100-200 basis points above the international rates, along with increased safety for their deposits.

As expected, India's current account flows continued to be negative although slightly on the higher side vis-à-vis the previous year. Capital account flows continued to be positive, growing by five per cent to $38.6 billion. But at the end of the day, what is noteworthy is the fact that there was a significant accretion through valuation change. The valuation change last year was quite substantial.

Also, the first half of the current fiscal stands out compared to the crisis year, 2008-09. As against a net inflow of $6.7 billion during the first six months of the current fiscal, there was net outflow of $57.7 billion during that 12-month crisis year. The principal driver for the foreign exchange drain in 2008-09 was change in valuation which eroded $37.6 billion. The problem was further compounded by FIIs taking out $15-billion worth of portfolio investments.

There was an exodus of fickle capital like short-term trade credit which registered an outflow of $5.7 billion. The saving grace was the net inflow of $4.2 billion as NRI deposits, even though the flow of banking capital remained negative at $3.3 billion.

cj@thehindu.co.in