From Two Weeks to 11 Months: India’s Forex Revolution

Part 1: The journey from US$1.2 billion in reserves to US$729.3 billion is one of India’s great economic transformations. Part I examines how the foundations were laid.

India once had enough foreign exchange to pay for barely two weeks of essential imports. Today, it has enough to cover nearly 11 months of merchandise imports. The distance between those two numbers tells one of the most consequential economic stories of modern India.

India’s foreign exchange reserves touched a historic high of US$729.3 billion in the week ended August 21, providing a formidable cushion against external shocks. The reserve stock is sufficient to cover nearly 11 months of merchandise imports and represents about 94 percent of India’s external debt outstanding as of March 2026.

The contrast with June 1991 could hardly be starker. Then, India’s foreign exchange reserves had fallen to just US$1.2 billion, barely enough to finance two weeks of essential imports, leaving the country on the brink of sovereign default. Over the ensuing decades, structural reforms, trade liberalisation, prudent fiscal management and sound monetary policies transformed India’s external sector.

The dramatic rise in reserves, which have grown at nearly 20 percent annually over the past 25 years, reflects not merely economic expansion but a fundamental change in the Reserve Bank of India’s approach from managing scarcity to building resilience and safeguarding long-term macroeconomic stability.

Tight Regime

Before the 1991 reforms, India’s external sector operated under the highly restrictive Foreign Exchange Regulation Act, 1973, which was built around the assumption of chronic foreign-exchange scarcity. The country followed a tightly managed exchange-rate regime that often left the rupee overvalued, undermining export competitiveness.

During the 1980s, economic growth was increasingly financed through external borrowing. Rising fiscal deficits and growing dependence on debt coincided with a rapidly expanding import bill, particularly for crude oil. The fragile model finally unravelled in 1990-91.

The Gulf War triggered a sharp surge in oil prices, increasing import costs while remittances from Indians working in the Middle East fell. The collapse of the Soviet Union disrupted a crucial trading relationship. Political instability at home further damaged investor confidence, causing capital outflows and withdrawals of NRI deposits.

By June 1991, India was on the brink of sovereign default. The crisis had been building for months, but the absence of a stable majority government at the Centre limited policymakers’ ability to take decisive corrective action.

Recognising the gravity of the situation, the Chandra Shekhar government took the unprecedented step of monetising India’s gold reserves to secure emergency foreign exchange. In May 1991, around 20 tonnes of government-owned confiscated gold were transferred to the Union Bank of Switzerland, raising approximately US$200 million.

That infusion was insufficient against the scale of the balance-of-payments crisis. The RBI was consequently compelled to pledge an additional 46.91 tonnes of its own gold with the Bank of England and the Bank of Japan. Completed in July 1991, the transaction mobilised nearly US$405 million in foreign-currency resources.

Although the operation was conducted discreetly, news of the gold pledge eventually became public, triggering widespread outrage and a sense of national humiliation.

The emergency measures provided vital breathing space. More importantly, they bought the time needed for a comprehensive programme of economic reforms that would fundamentally alter India’s economic trajectory.

Recognising that an overvalued currency was draining foreign-exchange reserves, the government asked the RBI to devalue the rupee by 20 percent in two tranches. This effectively ended the rigidly pegged exchange-rate system while improving export competitiveness.

In his Budget speech, Dr. Manmohan Singh launched sweeping structural reforms, signalling to global institutions that India was prepared to undertake the painful adjustments required for a comprehensive bailout.

The crisis thus became the catalyst for a new external-sector philosophy.

Scarcity to Resilience

The trauma of the 1991 balance-of-payments crisis and the politically sensitive gold pledge convinced policymakers that the RBI’s role had to evolve from rationing scarce foreign exchange to actively building a resilient reserve buffer.

To chart this transformation, the government constituted the High-Level Committee on Balance of Payments under Dr C. Rangarajan. The committee advocated a market-determined and realistic exchange rate, alongside the gradual liberalisation of current-account transactions, to enhance export competitiveness and integrate India more deeply with the global economy.

At the same time, it cautioned against premature capital-account liberalisation. Capital flows needed close oversight to prevent instability and ensure that external liabilities remained manageable.

Importantly, the committee argued that the current-account deficit should be treated as a policy ceiling, not a target, and contained at around 1.6 percent of GDP to safeguard long-term external sustainability and prevent a recurrence of past vulnerabilities.

Moving from a tightly controlled, state-administered foreign-exchange regime to a market-oriented system required a carefully managed transition.

A pivotal step came with the introduction of the Liberalised Exchange Rate Management System, or LERMS, in March 1992 that struck a balance between macroeconomic stability and gradual liberalisation. It shielded the economy from inflationary shocks while familiarising businesses with market-based exchange rates.

Its success paved the way for the unification of exchange rates in March 1993 and, subsequently, India’s acceptance of IMF Article VIII obligations in August 1994. This established full current-account convertibility and signalled the country’s commitment to a more open and globally integrated economy.

India’s transformation from a chronically forex-starved nation into a global liquidity powerhouse did not come from simply accumulating dollars. It came from engineering a macroeconomic ecosystem capable of generating, attracting and sustaining foreign exchange.

The dismantling of the Licence-Permit Raj, reduction of prohibitive import tariffs and sweeping liberalisation of foreign-investment norms fundamentally altered the composition of India’s balance of payments.

The legislative cornerstone of this new ecosystem was the repeal of FERA and its replacement by the Foreign Exchange Management Act, or FEMA, in 1999. The shift in language - from “Regulation” to “Management” - accurately captured the changing economic philosophy.

FEMA was designed to facilitate external trade and payments, promote the orderly development of the foreign-exchange market and encourage foreign-capital participation without criminalising enterprise.

India continued to run persistent merchandise trade deficits because of its structural reliance on imported crude oil, capital goods and gold. But these deficits were increasingly offset by a powerful stream of invisibles.

Structural Transformation

The meteoric rise of India’s IT and software businesses transformed the country into the back office of the world, creating a robust non-debt source of foreign exchange. At the same time, remittances from India’s vast and growing global diaspora provided a stable annual flow of dollars. The capital account also underwent a dramatic transformation.

The government systematically raised sectoral caps on foreign direct investment and opened Indian equity markets to foreign institutional and foreign portfolio investors. India began attracting vast sums of global capital.

The establishment of the Expert Group on Foreign Exchange Markets in India, or the Sodhani Committee, in 1995 further catalysed this process. Its recommendations on risk management tools, hedging instruments and the deepening of forward markets gave foreign investors greater confidence that they could manage currency risks while operating in India.

The result was a structural capital-account surplus that consistently outpaced the manageable current-account deficit. This net-positive balance of payments funnelled billions of dollars into the domestic financial system, providing the raw material for the RBI’s reserve-accumulation strategy.

From a precarious low of just US$1.2 billion in 1991, India’s foreign-exchange reserves rose to US$21.7 billion in 1995-96 and US$42.3 billion by 2000-01.

The momentum accelerated. Reserves reached US$151.6 billion in 2005-06 and more than doubled to US$309.7 billion by 2007-08.

Yet this remarkable accumulation was not simply the result of the RBI stockpiling foreign currency. It reflected the profound transformation of India’s external sector.

Economic liberalisation, stronger export performance, rising remittance inflows, growing foreign direct and portfolio investment and deeper integration with global markets dramatically expanded India’s foreign-exchange earnings.

As India’s economy became larger, more diversified and more globally connected, reserve accumulation became a consequence of sustained external-sector strength rather than a policy of simple reserve hoarding.

The journey from US$1.2 billion in 1991 to US$729.3 billion today is the story of India learning, painfully, that external stability cannot be improvised in a crisis. It has to be built in advance.

(The writer is a Chartered Accountant with a leading Mumbai-based company. Views personal.)