Dwindling forex pile may limit India's rupee defence, says BofAML

Eight months of import cover critical to rupee stability

India’s foreign-exchange reserves are shrinking fast and may soon reach a level that could hamper the central bank’s ability to defend the rupee, according to Bank of America Merrill Lynch. The solution lies in luring dollar flows by tapping overseas Indians, the bank said.

From a record $426 billion in mid-April, reserves have fallen by nearly $33 billion as the Reserve Bank of India sold dollars to stem losses in Asia’s worst-performing currency. A further $15-$20 billion erosion will leave the nation with an import cover of eight months, according to Indranil Sen Gupta, India economist at BofAML.

“You have sold so much that your ability to sell is becoming more and more constricted,” he said. “The amount of reserves, whether it is $400 billion or $800 billion, doesn’t matter. What matters is if you have enough to cover imports, short-term debt and flows.”

Reserves plunged $5.14 billion in the week ended Oct. 12, the biggest drop in seven years, suggesting the Reserve Bank of India intervened to curb the rupee’s decline. The support helped the currency recover 1.4 percent from a record low of 74.4825 per dollar on Oct. 11. The rupee lost 0.3 percent Friday to 73.4675 in Mumbai.

India’s FX reserves further declined by nearly a billion dollars to $393.5 billion as of Oct. 19, the central bank said in a statement Friday.

The reserves adequacy is “not much better off” compared with 2013, the year of the taper tantrum that saw the rupee tumbling along with its emerging-market peers, Gupta said.

Import cover stands at nine months versus seven months five years ago, the ratio of reserves to short-term debt plus current-account deficit is 1.4 times higher, and foreign inflows are 130 percent of reserves versus 100 percent back then, he said.

Bring It Home

The metrics show “you are not on a strong wicket,” Gupta said, making the case for turning to non-resident Indians for raising as much as $35 billion via bonds or deposits. The option was used in 2013, when a discounted swap window lured inflows of about $34 billion. Overseas Indians were also tapped in 1998 and 2000 to ease pressure on the rupee.

While the RBI in 2016 used about three months of import cover as a measure of reserves adequacy, India’s increasing links with global markets has led it to also consider two other metrics -- short-term debt and volatile capital flows -- to gauge if it has enough arsenal for a rainy day.

READ: India Is Said to Plan Tapping Its Citizens Abroad to Prop Rupee

“You have to demonstrate to the market that you can raise foreign reserves rather than just sell reserves,” Gupta said. “In all previous crises, you showed that you can raise reserves, and NRI bonds is the best way to demonstrate that again.”