Shoring up forex reserves will help if the US raises interest rates

The rupee moved above the 60 mark against the dollar on Friday to hit the intra-day low of 59.68. But the Reserve Bank of India is not complaining. It is instead making the most of rupee strength in recent months, using this opportunity to add to its forex reserves.

Data released by the Reserve Bank of India on net sale and purchase of dollars by the central bank reveal that it has net purchased $15.5 billion between October 2013 and January 2014. While the central bank has net-purchased dollars in the three months from October to December 2013, it has net sold $1.9 billion in January 2014. The selling in January might have been due to the rupee retreating to 63 level against the greenback in that period as the Federal Reserve announced the second phase of the QE taper.

According to a report released by Bank of America Merrill Lynch, the RBI has bought $5 billion, including dollars purchased on maturity of swaps with oil companies since mid-March.

“We continue to believe that the RBI will need to recoup about $80 billion of forex reserves to stabilise the rupee,” says the report. “The good news is that sentiment has turned in favour of the rupee. Many investors, for example, are buying INR and selling other Fragile Five currencies.”

Not comfortable enough

The forex reserves have improved since September last year on the slew of initiatives of the RBI including offering a dollar swap window for FCNR (B) deposits and Banks’ Overseas Borrowings.

From the lows of $275 billion in September last year, reserves have increased 8 per cent to $297 billion on March 14, this year. This is, however, still well below the high of $321 billion recorded in September 2011. The import cover too – while showing an improvement at 8.8 months of imports – is not comfortable enough.

Further volatility?

Foreign fund flows into the country have so far been robust with $9.4 billion brought in so far this calendar in equity and debt. These flows have been adding to rupee strength making the Indian currency move above 60. The rupee is also relatively stronger when compared to other emerging market currencies.

The 36-currency trade weighted value of the rupee, adjusted for inflation (REER) is at 95, implying that the rupee continues to be competitive in relation to the currencies of its trading partners.

This therefore appears to be a good time for the central bank to be adding to its dollar reserves.

If the flows reverse after elections or if the foreign investors reduce their purchase in Indian debt instruments as the US begins increasing its interest rate, having a stronger forex reserve will stand the country in good stead.

(This article was published on March 28, 2014)
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