The forex chest's swell: Valuation gains to lift India's reserves

India’s foreign exchange reserves, at a sizeable $699.9 billion as of October 3, represent a healthy level, according to adequacy yardsticks such as import cover and external debt servicing requirements.

 

In times of lingering geopolitical uncertainties and market volatility, that fourth-biggest hoard in the world is a bulwark. The country’s current account deficit (CAD) remains comfortable as well, coming in at 0.2 per cent of gross domestic product (GDP) in the first quarter of the financial year.

 

But when capital flows are volatile, as has happened this financial year, even financing a low CAD can become challenging and put pressure on the currency. In the first half, for instance, foreign portfolio investment (FPI) recorded a net outflow of $3.9 billion, as opposed to a net inflow of $21.6 billion in the year-ago period.

 

Evolution of reserve management

 

Efficient forex management is crucial to ensure a reasonable level of confidence in the international financial and trading communities about the capacity of a country to honour its obligations and maintain trade and financial flows while minimising the liquidity risk.

 

India has come a long way both in terms of the quantum of reserves and the management practices thereof. Today, foreign exchange reserves account for nearly 17 per cent of India’s GDP, compared with just 1.3 per cent in FY91 during the balance of payments crisis.

 

Reserve management practices, too, have evolved, starting with the recommendations of the 1992 High-Level Committee on Balance of Payments and the lessons from the 1997 East Asian crisis. The approach has broadened and now factors in the size, composition, and risk profiles of capital flows, as well as vulnerabilities to external shocks.

 

India’s CAD conundrum

 

India has ranked fourth in terms of foreign exchange reserves for many years now. However, there is one big difference compared with the top three holders — China, Japan, and Switzerland: They all enjoy current account surpluses.

 

This makes it convenient for their central banks to build  reserves that are stable in nature. With export income higher than the import bill, there is appreciating pressure on their currencies. So, the central banks keep buying dollars to check appreciation in their currencies and ensure competitive exports.

 

India, on the other hand, runs a current account deficit. Its foreign exchange reserve buildup depends on capital inflows, part of which is in the form of debt (external commercial borrowings and non-resident Indian deposits) and must be repaid at some point in time.

 

Foreign portfolio investment flows help but are relatively fickle. Foreign direct investment is the more stable form of capital flow, but here too, India has been experiencing some pressure on a net basis. The buildup of India’s foreign exchange reserves, therefore, has been more opportunistic and requires active management.

 

Mint Road agility

 

Many factors impact reserves. One of these is the valuation effect, which refers to changes in the exchange rates of major reserve currencies, along with the fluctuation in the market prices of foreign securities — the mark-to-market math.

 

These impact the FCA, or foreign currency assets component — the largest — of the forex reserves. The other valuation impact comes from the movement in gold prices. The valuation effect has had a key role in raising the reserves at a time of tapering net capital inflows.

 

If not for the valuation effect in FY25 and in the first quarter of this financial year, the total foreign exchange reserves would have been $52.2 billion lower. According to the Reserve Bank of India, the valuation gain of FY25 reflected higher prices of gold and lower yields on international bonds. The RBI has shown laudable agility by increasing gold holdings by 58 metric tonnes last financial year, prices of which have surged since.

 

Gains to continue

 

The valuation gains bode well for this financial year as well. Given lingering global uncertainties, India’s current account would be a touch higher this financial year, while financial flows may remain volatile and inadequate.

 

The United States’ move to impose high tariffs on India has also put considerable pressure on the rupee. Moreover, the RBI’s net forward assets (payable), though down from the historic high of $88.75 billion at end-February 2025, remained elevated at $57.9 billion as of July. For a central bank to tackle the trifecta, a substantial foreign exchange kitty is essential.

 

Luckily, factors that lead to the valuation gain are still playing out favourably. Gold prices have caught fire, and the US dollar has depreciated against the pound and the euro, providing a favourable exchange rate movement to boost India’s FCA. Yields on US Treasuries have softened. The 10-year yield has averaged 4.11 per cent in October so far, compared with 4.27 per cent in April 2025, and may fall further as the Federal Reserve has kickstarted its easing cycle.

 

Overall, the valuation gains are expected to continue playing a positive role in the movement of India’s foreign exchange reserves this financial year.

 

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The authors are, respectively, chief economist, senior economist, and economic analyst, Crisil Ltd