Depleting forex reserves making India vulnerable? Not really, say experts

At the current rate, the reserves may provide cover for eight months of imports in FY23. Four months could be considered a danger mark

A debate has been going on over the depletion of foreign exchange (forex) reserves. While many have cautioned against reducing reserves, the finance ministry had said the concerns are "overblown."

To test which side is correct, let us assess the economy's vulnerability due to depleting forex reserves. A Reuters poll on Monday said that its median results showed that forex could fall to $ 523 billion at the end of the current financial year.

If this happens, the reserves would be the lowest in three years. However, the more significant issue is the reserves would provide cover for imports for just 8.22 months, which is the lowest in nine years. Here imports are calculated based on the five-month trend of the current financial year.
 

Before this, it was way back in 2013-14, when a taper tantrum happened, that the forex reserves provided cover to imports for less than 8.22 months. At that time, the cover was sufficient for imports for 7.83 months. Two years prior, with headwinds blowing — in 2012-12 and 2012-12 — the cover could finance imports for about seven months. 

The cover was sufficient for about ten months, even in 2008-09, when India faced the ripple effects of the global financial crisis.

Does it mean India is vulnerable to external shocks now?

"Not really. Four months would be the danger mark. We need to observe how capital flows turn out, which can buffer against rising trade deficit," Bank of Baroda chief economist Madan Sabnavis said.

While $18.9 billion of net FDI has come in during the first four months of the current fiscal year, foreign portfolio investors (FPIs) have been net sellers of $49.4 billion till September 28 of this financial year.

ICRA chief economist Aditi Nayar said commodity prices are correcting, but its impact has not been seen on import bills.

"If there is a global slowdown and commodity prices continue to correct, depleting forex reserves would be less of a concern. Currently, imports at over $60 billion a month are very high," she said.

She is hopeful that lower commodity prices would reflect in the import bill from the third quarter. If that happens, then forex reserves would cover imports for a much longer period than 8.22 months, she said.

Sabnavis said RBI may not sell those many dollars keeping prudential limits in mind.

On Monday, finance minister Nirmala Sitharaman said the RBI had used nearly $75 billion to arrest the rupee volatility against the dollar. The rupee fell 36 paise to close at a fresh record low of 81.94 on Wednesday.

Besides import cover, there is another test of the soundness of forex reserves. It is the cover that these provide to external debt.

The data on external debt for the first quarter of the current financial year has not been released yet. Still, if one takes average growth of 2.7 per cent in two pre-covid years of 2018-19 and 2019-20 and then calculates external debt for 2022-23, the forex reserves would cover 82 per cent of external debt, which would be a four-year low.

Previously, it was in 2018-19 that forex provided cover for 76 per cent of external debt. Even in the crisis year of 2008-09, forex reserves exceeded external debt by 12.2 per cent.

Nayar said external debt is not a worry.

This is also so because short-term liabilities constituted around 20 per cent of external debt in 2021-22. More the portion of short-term debt in external debt, the more vulnerable the country becomes to external shocks, as was witnessed by east Asian countries in the late 1990s. 

Forex reserves were down for a seventh continuous week, dropping to$545.65 billion on September 16. The reserves have been dipping as the central bank deploys the forex kitty to defend the currency.