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India’s foreign exchange reserves crossed the $400-billion mark in early September, surging 8 per cent over the past year, a period when the Reserve Bank of India went on a dollar-buying spree.
The pace of build-up of forex reserves also coincides with the rupee’s sharp rally since January. A surge in inflows from foreign investors, coupled with a weakening dollar, helped the rupee climb from 68 to 65 against the dollar this year.
The RBI has been making the most of the rupee’s strength by buying dollars continuously, pushing the reserves higher. Between August 2016 and July 2017, the RBI purchased $18.9 billion, almost thrice the $6.7 billion it purchased during the same period in the previous year.
The central bank action serves two purposes. Healthy reserves can insulate the rupee from the shocks of a large fund outflow in the future; and they keep the rupee from strengthening too much and hurting the exporter. The move to bolster the reserves began four years ago, when Raghuram Rajan took over as RBI Governor in September 2013. From $277 billion then, the reserves have risen 45 per cent.
As of July, the RBI had an outstanding forward position of around $26.5 billion. “Whenever we talk about the reserves, we need to consider the RBI’s forward positions also. Including the forward positions, our reserves are now around $429 billion,” says Sajal Gupta, Head of Edelweiss Forex and Rates.
More import cover
The reserves can now cover about 11 months’ imports. Data from Edelweiss Securities shows that the country’s import cover improved from around seven months in 2013 to 13 months in 2016, but has come down since then. “Increase in imports brought down the import cover over the past year,” says Gupta. He believes the import cover could improve to 12 or 13 months in the future due to strong inflows into India and on expectation of a slowdown in imports.
An import cover between eight and nine months is adequate, experts say. A report from the Bank of America Merrill Lynch states that eight months’ import cover is needed for rupee stability.
An EM phenomenon
The strong build-up in forex reserves is not unique to India; the phenomenon has been witnessed in other emerging markets also. Except China, other BRICS nations have seen their forex reserves rise. Data available till August show that the reserves (ex-gold) of Brazil and Russia have risen by 3 per cent and 6 per cent over the past year. Most central banks have been buying dollars and building up reserves as the dollar index fell. Dollar liquidity and flows into emerging markets have seen an EM-wide rise in reserves.
On the other hand, China’s forex reserves have depleted by 3 per cent over the same period. This has happened in the backdrop of measures to control the money flowing out of the country and the central bank selling dollars to arrest the weakening Chinese renminbi.
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