Why have India's forex reserves hit a new low

Disclaimer: The views expressed in this article are those of the author and do not necessarily reflect the views of the Economic Times – ET Edge Insights, its management, or its members

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Why have India's forex reserves hit a new low

India’s forex reserves have hit a new low. As a result of the US Federal Reserve’s tightening of policy rates and  the confluence of various geopolitical events, India’s robust foreign reserves of $600 billion were sufficient to pay a year’s worth of imports, down 30% from March 2021.

According to Reserve Bank of India (RBI) data issued on April 8, India posted a 17-month high inflation rate in March, has seen the steepest weekly decline in its foreign reserves ever.  India’s foreign reserves fell by $11.173 billion to $606.475 billion as the currency was under pressure owing to geopolitical developments. This sum is equal to a year’s worth of merchandise imports in 2021-22, or 98.8% of total external debt as per media reports.

The RBI continues to intervene in the currency markets through dollar sales to keep the rupee from falling in value amid the Russia-Ukraine war, with the country’s forex reserves facing a steep decline as per various newspaper reports. Let’s take a closer look at the key reasons for India’s dwindling forex reserves.

Increased crude oil prices:  The rupee was heading towards the 77 mark as the Russia-Ukraine conflict escalated and crude oil prices soared. The Reserve Bank of India (RBI) sold dollars through PSU banks to avert a further decline in value during a geopolitical crisis caused by the Russia-Ukraine conflict.  On March 8, the RBI sold $5.135 billion to banks while also agreeing to buy the dollars back at the end of the swap-settlement period. When the central bank sells dollars, it withdraws the same amount in rupees, diminishing rupee liquidity in the economy. At the time of writing, one US dollar is equal to 76.25 Indian rupees.

Currently, India’s record foreign exchange (forex) reserves may not be sufficient to protect the rupee from the effects of rising oil prices. Despite record forex reserves, India’s entire import bill increased dramatically in the first nine months of FY22, resulting in a decrease in import cover.

Foreign investors withdrawing:  Foreign investors withdrew Rs 41,617 crore in March, putting significant pressure on the rupee. After withdrawals of Rs 45,720 crore in February and Rs 41,346 crore in January, this outflow has occurred. Since October 1, 2021, FPIs have withdrawn out Rs 225,649 crore (excluding FPI investments in IPOs), primarily in anticipation of a rate hike by the US Federal Reserve. The withdrawal of foreign investors is not surprising as the looming US Fed rate hikes means that would want to move to safer investment havens from relatively risky investment destinations like India.

Furthermore, as the Russia-Ukraine conflict has escalated, Brent crude prices rose to a near 14-year high of $140. Because India imports roughly 80% of its domestic needs, high crude oil prices would have resulted in a significant increase in the dollar demand. According to various news reports, the foreign reserves fell by approximately $26 billion in March 2022 alone.

Rising fiscal deficit:  Only two months into this fiscal year, the government’s fiscal deficit has risen to 58.6 percent of the current fiscal year’s budgetary target, owing to increased spending to combat the virus. Another hypothesis is that the government is storing these funds as a “Plan B” in case India’s strategic disinvestment plans fail. Third, after several revisions to India’s GDP growth predictions, FX reserves are likely to be a way for the country to maintain its global grade. Fitch, for example, cut its India growth prediction for 2021-22 from 9.5 percent to 8% on June 30. The government requires something to hold onto for its investment.

The confluence of the aforementioned factors means that there is a precipitous decline in global investor sentiment in third world economies such as India. The country needs to find a window to script an economic turn in the near and long term.

Disclaimer: The views expressed in this article are those of the author and do not necessarily reflect the views of the Economic Times – ET Edge Insights, its management, or its members

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