Forex reserves falling below $400 billion not a worry, say experts

India’s foreign exchange reserves could go below $400-billion mark. However, experts say this in itself should not be a cause for concern.

The reserves accumulation happened through portfolio flows, and now that those flows have reversed, putting pressure on the currency, the central bank is right in giving up some of its accumulated reserves defending the rupee, said market experts and economists. 

India’s forex reserves peaked at about $426 billion in mid-April. Since then, it has come down to $405 billion in the week ending July 20, the data from the Reserve Bank of India (RBI) shows. There’s another $10-11 billion worth of forward position of the RBI, which is not counted in the reserves, but can be used to intervene in the market.

The forex reserves were accumulated due to portfolio flows. As dollar money flew into local equities and debt, the RBI kept buying the flows, so that the rupee did not strengthen too much. 

In early September 2017, the reserves had touched $400 billion for the first time, as the RBI had added a net $40 billion of reserves in its kitty since January, 2017. It was aided by a portfolio flow of about $27 billion in debt and equities.

The portfolio flows started reversing this calendar year. Year-to-date, the outflow in equity and debt has been a little more than $7 billion, with the debt segment alone accounting for $6 billion.

Still, the central bank had to intervene aggressively, mainly because China let its currency devalue against the dollar and all Asian currencies, including the rupee, depreciated.

But the recent drop in reserves doesn’t mean it will continue to remain so. As currency depreciates, it also becomes an attractive investment destination for carry traders.

“Though India witnessed FPI outflows in the past six months in equities and debt from India of about $6.5 billion, and RBI intervention of around $25-26 billion reflecting the dip in reserves, the possibility of sharp fall in reserves from here seems a bit low. The emerging markets are stabilising, which shall have a positive impact on India,” said Manish Wadhawan, the head of fixed income, global markets, HSBC India.

“The trade tensions, Fed actions, commodity markets, especially oil, emerging market currencies, especially yuan, are key factors to be watched. India’s current account has been impacted by the high oil prices but recent rupee depreciation shall help restore flows as the assets become attractive to investors. In fact, the intervention by the RBI has been a stabilising factor in the currency markets,” Wadhawan said.

But if the RBI has to reaccumulate its reserves, or stop letting it erode further, there are many options the central bank can adopt, for example imposing capital controls. But those measures will have a steep negative impact on the country as an investment destination.

The central bank can also open a dollar swap facility with the oil marketing companies, such as the one it had engaged in 2013. Here, oil companies get dollars directly from the RBI and return it later. The market is not touched, eliminating the need for the RBI to intervene to that extent.

However, the best way for now seems to be raising dollars through deposit schemes such as the one done in 2013, where the RBI raised about $32 billion through non-resident Indians, or raising sovereign bonds in dollars. But those are probably some time away, and should be done at a time when the situation looks under control.

“If we have to do it, we will have to do it from a position of strength and not from a position of weakness. An NRI deposit at this point will introduce nervousness in the markets. Our reserves have come up by $100 billion in 10 years. Even if it falls by another $10-$15 billion now, it should not be a matter of concern,” said Soumyakanti Ghosh, group chief economist at State Bank of India.

According to Ghosh, no amount of reserves is enough to ward off a currency crisis, and therefore, clinging to reserves just for the sake of numbers doesn’t make sense.

Also, a number of economists also said that the situation would come under control in the coming days as US-China trade tension eases. Iran oil crisis is already showing some signs of improvement. This should be good for the rupee and the portfolio flows must resume.

Besides, on a standalone basis, India doesn’t have as much of dollar-denominated assets as some other countries in the region. And the short-term external debt is only about 25-30 per cent of the total reserves. Hence, the total reserves can be technically allowed to dip without much of a worry.