Forex Reserves
At around 570 billion USD, India’s foreign exchange reserves are at a 20-month low, even as the Rupee breached the 80 mark. In the week ended July 22nd, our forex reserves decreased by $9.64 billion, recording the steepest fall in the last two years. This trend is fuelled by the steady capital outflow that comes as a result of the Fed’s rate hikes to combat inflation. This, even as the RBI expects the rupee to withstand further depreciation.
In this week’s article, we seek to demystify the current ForEx dilemma for you: what is India’s current position, RBI’s current policy and the outlook for the future. Let’s begin:
Firstly, what are Foreign Exchange Reserves?
Foreign Exchange Reserves are the assets held by the central bank of a country in foreign currencies or bonds. Often referred to as the ‘Forex Reserves’, they are used to back liabilities and influence overall monetary policies of a country.
Mostly, forex reserves are held in USD due to the dollar’s prevalence in international trade. However, forex reserves also include other foreign currencies, bonds, treasury bills and other government securities.
Currently, China holds the largest foreign exchange reserve in the world, worth more than $3 trillion.
Why are forex reserves needed?
The main objective in holding forex is that it may be used to meet international financial obligations,such as financing governmental and commercial debts, as well as imports.
Additionally, forex serves the following purposes:
- It works as a shock absorber in the event of unexpected external events. For example, India was able to weather the Global Financial Crisis of 2008 because of its significantly large foreign reserves
- It aids in increasing investor confidence in a country’s ability to meet its external obligations.
What is the current situation with regard to India’s Forex Reserve:
As per the latest data by RBI, India’s foreign exchange reserve totalled $571.56 billion for the week ended July 22nd. That week saw a $1.426 billion drop in India’s foreign currency holdings, the largest component of the forex reserves. In the week that ended on July 15th, foreign currency assets fell by $6.527 billion, after falling by $6.656 billion the week before.
Other components of the currency reserves saw a growth. It’s worth $38.502 billion now, up from $38.502 billion in the week that ended on July 22nd. RBI revealed that there had been a $106 million increase in the value of Indian Special Drawing Rights (SDRs) held by the International Monetary Fund (IMF) during the week. In fact, India’s reserve position in the IMF rose by $23 million to $4.96 billion during the week ended July 22nd, as per the RBI’s Weekly Statistical Supplement.
The value of gold reserves rose sharply in line with the sharp appreciation in the gold price during the month. The value of gold reserves jumped by $1.522 billion to $43.842 billion during July ’22.
The graph below depicts the overall value of Indian Forex Reserves in the period August 21-Jul 22.
How has India fared?
In an attempt to contain the currency volatility in the markets, the RBI has been intervening in the forex market, by selling dollars from its Forex Reserves. The central bank is estimated to have sold $1 billion per day a week in July, to prevent further weakness in the rupee.
Over the last couple of years, RBI has prudently shored up its forex reserves. It is therefore highly unlikely that we will experience an acute crisis, in contrast to our neighbours, Sri Lanka and Pakistan. Recently, Professor Raghuram Rajan, former Chairman of the RBI, and a critic of the current dispensation, went on to laud the central bank for its ‘excellent job’.
In fact, on a comparative basis our currency has fared much better with respect to currencies other than the dollar, amid the geopolitical tensions between Russia and Ukraine. Since January 19th, although the Indian Rupee has fallen by 7.1% to breach the psychological level of 80 per dollar, our currency is doing reasonably better than most others.
As we can see from the above graph, India is not the only country who has suffered since the beginning of this year. In fact, in the past 6 months, the Indian rupee has appreciated with respect to the British Pound and Euro. The value of the British Pound has decreased by 13.69% in the last six months, while the Euro has registered an 11.3% fall. Since the inception of the Russia-Ukraine war, RBI has strategically made use of its forex reserves to shield our currency from steep depreciation.
The Reserve Bank Deputy Governor, Michael D Patra, in an interaction, stated that the central bank’s policy was to prevent “jerky movements” of the rupee. “We will stand for its(rupees) stability and we are doing it. We are there in the market and we will not allow disorderly movement of the rupee. We have no level in mind, but we will not allow jerky movement. That is for certain”, he said.
Although such comments come to the relief of investors, experts including leading economists stand divided on the efficacy of RBI’s strategy. Quite a few of them are critical of the ‘short-term’ view allegedly adopted by the RBI. And, amid the ongoing economy-wide capital outflow, certain crucial questions still remain: with our import bill on the rise, what percentage inflation is expected to follow from this Fed-induced depreciation? Moreover, with exports becoming cheaper, how optimistic should we be about the employment and growth it can fuel?
Our trade-deficit figures, as of 1st August, 2022, stands at a whopping $31 billion. Analysts point towards an emerging ‘twin deficit’ crisis in India. Declining forex reserves is a sign of weakness. It can be argued that a country derives its economic might from its stock of forex, given that the forex reserves are indicative of the reassuring power of its currency. India might be better off than its peers and even some developed economies. However, there is no denying that the situation is precarious and needs close monitoring.
Curated By: Nirbhik Das
(Nirbhik Das is a 2nd year student pursuing B.Com(H) at St. Xavier’s College (Autonomous), Kolkata and a Research Analyst of the Xavier’s Finance Community.)