India has around 470 billion USD in debt and has around 400 billion USD in forex reserves. So why should India or any other nations shouldn't use their forex reserves to pay off their external debt ?


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If you had 12,000 dollars owing on a loan, 10,000 dollars cash in the bank and 1000 dollars monthly expenses, but you weren't sure if incoming cash flow could stop for 6 or 12 months, any time, with no notice, would you deplete your entire cash stock to reduce debt?

At that point, if your next paycheque was a week late, you would go hungry. Or, assuming that you had assured your basic subsistence, you might find yourself with no money to buy some other basic things that make your life a lot easier or more efficient.

Otherwise stated, there's a reason that a common measure of forex reserves is "Total reserves in months of imports".

Basically, if India used all of its forex to pay off external debt, then on a moment's notice it could have zero (or at least highly constrained) ability to access critical inputs into production processes. The highly negative impact that autarky or excessive focus on self sufficiency (beyond subsistence needs) could be highlighted in the context of this explanation.

Also (among other things), while a lot of economists disagree that using forex to manage an exchange rate in a situation of short-term crisis is a good idea, it is logically true that if you have no forex then this option simply does not exist.

For a specific example of how this can be a problem, you could refer to the story of the 1997 Asian Financial Crisis. In response to this crisis, most central banks in Asia undertook to substantially increase their forex holdings in order to not suffer a repeat of such a crisis.


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