Reddy (2002, page 1913) notes that “....two factors are responsible for significant addition to reserves in the recent past viz, a far lower level of current account deficit (CAD) than the expected sustainable level of about 2 percent of Gross Domestic product (GDP) each year and a continued inflow of capital...”.

Table 4 confirms that the reserve increase was driven by the fall in the current account deficit after the 1991 crisis; the surplus on the capital account is more or less constant except for a small, apparently temporary increase during the Eighth Plan period. It divides the post-crisis reserve accumulation into three phases. The first is the Eighth Plan period, during which fiscal and current account deficits fell, while private investment rose from a rate of 13 percent of GDP during the second half of the 1980s to over 15 percent. The second is the Ninth Plan period, when fiscal deficits jumped upward, but the current account deficit fell further and reserve accumulation accelerated. Private investment rose slightly. The third phase is post-April 2002, when reserves have boomed and a small current account surplus has appeared.

**Table 4: Stages in Reserve Accumulation**

|_% of GDP_<br>_(period avg.)_|_85/86-89/90_|_8_<sup>_th_</sup>_Plan_<br>_92/93-96/97_|_9_<sup>_th_</sup>_Plan_<br>_97/98-01/02_|_2002/03_|
|---|---|---|---|---|
|Fiscal deficit|9.0|7.2|9.3|10.3|
|Investment<sup>1/</sup>|22.7|24.8|24.0|23.1|
|public|10.1|8.0|6.6|6.3|
|private|13.2|15.3|15.9|15.7|
|National savings|20.5|24.5|25.1|-|
|public|2.4|1.5|-1.1|-|
|private|18.1|23.0|26.2|-|
|Current account balance<sup>2/</sup>|-2.2|-1.2|-0.7|0.7|
|Capital account balance|2.2|2.4|2.2|2.3|
|debt-creating|2.2|1.2|1.1|1.4|
|direct and portfolio inv.|0.0|1.2|1.1|0.9|
|Increase in reserves ($ bn.)|-2.6|17|28|21|

Notes:

> <sup>1/</sup> : Adjusted for errors and omissions.  Hence, the components do not sum to total investment. 2/ : There are differences in estimation of CAB as per the National Accounts and the RBI. Thus the numbers do not yield the identity CAB = national savings minus investment. Source : National Accounts 2002 and various issues, Reserve Bank of India Bulletins.

The fact that private investment grew by much less than private saving during the Ninth Plan relative to the Eighth has been used to argue that the rising fiscal deficit absorbed part of the increase in private savings and to this extent crowded out private investment, thereby helping to keep the current account deficit in check.<sup>34</sup> We return to this point later in the paper.

The acceleration in reserve accumulation during 2002/03 and after raises two questions: (i) what is driving it? and (ii) how to manage the macroeconomic consequences. About 40 percent of the reserve increase during 2002/03 happened after November 2002. An unknown part of this might have been driven by capital inflows related to fears of the Iraq war, and therefore, this pace of accretion might not be maintained.<sup>35</sup> Another possibility is we are seeing capital

> 34 Ahluwalia (2002), Acharya (2001) and IMF (2002).

> 35 See RBI (2003b) and Kapur and Patel (2003).  Reddy (2002) contains a comprehensive account of foreign exchange reserves policy through the 1990s.

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