Bank of America (BofA) sees $550 billion as a comfortable foreign exchange (forex) reserve level for the Reserve Bank of India (RBI), and believes that the central bank will continue to accumulate dollars at every opportunity, even at the cost of a weaker rupee.
As of February 14, the RBI’s forex reserves stood at $476 billion. The central bank has bought $49 billion in this fiscal year so far, more than offsetting the $15.4 billion sale in 2018-19.
According to BofA, the ‘conservative’ level of forex reserves for the RBI works out to be $550 billion.
According to BofA’s economists Indranil Sen Gupta and Aastha Gudwani, there are three reasons why the RBI would want to accumulate more reserves — to maintain more import cover, fully covering foreign portfolio investors’ investments, and to maintain a healthy cover on short-term external debt of India.
The one-year forward import cover has slipped to 11.1 months from 14.4. “The reason it looks relatively high is that low growth has pulled imports to 16.4 per cent of gross domestic product (GDP) from the average 21.9 per cent since 2005-06.”
To maintain import cover at 20 per cent of GDP, India would need at least $535 billion of forex reserves, the duo said.
Second, to maintain 100 per cent cover for FPI investments would require at least $520 billion. Finally, to take care of the short-term external debt and FPI’s debt investments, India would need to maintain twice the exposure in foreign exchange. That works out to be $594 billion.
BofA sees rupee at 70.5 a dollar in March 2020.