Slip aside, India sitting pretty on its Forex Reserves

At USD 590 billion, India seems to be sitting pretty on its forex reserves. The current slippage is primarily on the strengthening dollar and rising bond yields after the Fed’s commentary on a ‘higher and longer’ interest rate. Things will improve in time.     

The Dollar’s rise has triggered depletion in India’s foreign exchange reserves to a four-month low of USD 590.7 billion as of 22 of September. It has been on the southward move over the past three weeks and the real shot in the arm for the greenback’s ascent has been the US Federal Reserve’s guidance on the interest rates to keep it higher for longer.

the world’s largest central bank in its recently concluded Federal Open Market Committee Meeting (FOMC) said that it would undertake a 50-bps rate cut next year against the expectations of a 100-bps cut amid data that suggests that inflation would remain elevated for a long time. Chair Gerome Powell in his monetary policy speech said that the Fed would most likely undertake another rate hike this year before taking a long pause as it left federal rates unchanged this time at 5.25-5.50 per cent. The existing rates are at two-decade high, much to the discomfort of the emerging economies.

What this policy speech did was that it dashed hopes of a higher rate cut to bring the current rate regime lower. It also shook confidence about the inflation situation as the world was hoping that a price stability would come back not long ago. The commentary and the Fed action resurrected the belief that inflation was not going anywhere in the near term.

By virtue of the US being the world’s largest economy and the dollar being a global currency, the latter is also considered to be the biggest hedge against economic or geo-political uncertainties. When global economies falter due to unforeseen events, the demand for dollars goes up, aiding to its strength. Economies and businesses start buying dollars to hedge their losses and this has a cascading effect on the fortunes of other currencies. To summarise the point, they get weakened.

When the Fed said that it would have to keep rates higher for longer, the dollar strengthened and bond yields rose up, which in turn caused an exodus of money from emerging markets, including India. There was very little that governments or central banks of emerging countries could do in a situation such as this.    

In India’s case, the foreign exchange reserves declined to USD 590.7 billion as of 22nd of September, according to data released by the Reserve Bank of India (RBI). The forex outflow was to the tune of USD 2.3 billion during the week, following an investment exodus of USD 5.9 billion in the previous two weeks.

According to a Reuters report’s break up of foreign assets, India’s foreign currency assets stood at USD 523.36 billion as on September 22, 2023; gold at USD 44.30 billion, SDR (SDR Special Drawing Right) at USD 18 billion and Reserve Tranche Position in the International Monetary Fund at USD 5 billion.

The money which leaves from emerging markets to the developed markets is largely from stocks and bond markets. 

Investors leave emerging markets for greener pastures which are the US or European economies where bond yields go up. This is not to say that the bond yields do not go up in emerging economies but they are not as attractive as in the developed economies.

There is a double whammy — one is the money leaving the emerging markets and the other is that even if the Foreign Portfolio Investors (FPIs) or Foreign Institutional Investors (FIIs) do not pull out of their investments, the forex reserves go down because of the higher exchange rates. 

In India, while FPIs have pulled out some of their investments, a higher Rupee-Dollar exchange rate has also been the culprit. The dollar index is at its six-month highs while the rupee is trading near its 10-month lows as per the interbank exchange rates. 

According to experts, the dollar index (DXY) could climb up to the levels between 108-109 in the medium term against six major currencies. Currently, the DXY is trading above the 106 mark. 

The Indian Standpoint

India is a large importer of crude oil with nearly 80 per cent of its consumption met through imports. When the dollar starts ticking up, the oil market companies start buying dollars to curtail their losses. The same is the case with companies which import services or raw materials.

On the other hand, the RBI begins selling of the USD to lower the demand for dollars and reduce rupee volatility. This is a common phenomenon followed by most central banks to preserve their currencies.

According to a report published by the Indian Express, the RBI became a net seller of the US dollar as on date in FY2023, after remaining a net purchaser for three consecutive years. It sold USD 25.52 billion on a net basis in the spot foreign exchange market. 

To India’s credit, despite the challenges, it has been able to contain its current account deficit (CAD) and has not allowed it to balloon up. But the road ahead could be tricky. While it has narrowed its CAD on the year-on-year basis, the deficit has widened on the quarter-on-quarter basis to USD 9.2 billion, or 1.1 per cent of the GDP, in the first quarter of the current fiscal year. In Q1FY23, India reported a CAD of USD 17.9 billion, which was 2.1 per cent of GDP, in Q1FY23. Meanwhile, In the January-March quarter, the CAD was at USD 1.3 billion.

If the oil prices remain high and the strength in dollar index remains intact, it is likely that the CAD will cross the 2 per cent of GDP mark.

Notwithstanding the current upheavals, the forex reserves remain strong. The dollar is expected to correct once the sentiments around the interest rates subside. We are still much better-off from the times when the dollar index hit an all-time high of almost 115. 

Moreover, India’s position as the fastest growing major economy remains in place and with the size of its markets, Investments getting back is only a matter of time.

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