Data Focus

Following record accretion, RBI stops adding to its forex kitty since February

Lokeshwarri SK Chennai | Updated on March 17, 2021

 

India’s foreign exchange reserves are amongst the highest globally, standing at $580 billion as on March 5, 2021. But the reserves have been gradually declining since February this year. From peak level of $590 billion on January 29, 2021, reserves have declined around $10 billion, or 1.6 per cent from the peak.

This decline is due to a number of reasons including the Centre’s large borrowing for FY22 and rupee weakness caused by rising crude oil prices and spike in US dollar, giving RBI the room to go slow with dollar purchases.

Sharp increase in FY21

India’s forex reserves were, however, up a strong 21 per cent between April 2020 and March 5, 2021.

This was largely thanks to the central bank policy of mopping up the deluge of FPI inflows since last April. Foreign portfolio investors net purchased ₹2,65,949 crore of equity in FY21 so far. While they have withdrawn ₹53,624 crore out of Indian debt market, this has not mattered to the overall flows.

The strength in the rupee last year, against the dollar also gave the central bank room to buy dollars. Of the total accretion of $102 billion in FY21 so far, 95 per cent was in the form of foreign currency purchases, caused by RBI’s purchases of dollars. Appreciation in gold prices appears to have resulted in value of gold holding increasing 12 per cent in the first 11 months of this fiscal year.

But the decline in forex reserves since the beginning of February 2021 suggests that the central bank has changed its policy after the Budget.

Large govt borrowing

The obvious reason for this is the large government borrowing, amounting to over ₹12 lakh crore for FY22. With the absorbing capacity of the market to this deluge of paper being questionable, the central bank would have to buy some of the government paper too, thus affecting its capacity to keep buying the excess dollars from the market.

Few other reasons could also have affected the central bank decision on forex reserve accretion. One, the sharp spike in crude oil prices since February due to production cuts from OPEC plus countries and from the US due to cold weather has resulted in shrinking the trade surplus that the country was enjoying. This impacted the rupee negatively, making it depreciate towards 73.6 against the dollar by the end of February.

Two, the US dollar strengthened sharply from mid-February due to strengthening treasury securities yield in the US. This too resulted in applying downward pressure on the rupee. With the rupee facing duress, the RBI would have used some of its reserves to sell dollars since mid-February to stabilise the rupee, leading to fall in reserves.

The RBI has also been buying dollars in the forwards market with its outstanding net forward purchases of dollars towards the end of December 2020 standing at $39.7 billion. While the reason for buying could have been to manage the forward premia, these positions will come in handy to support the rupee if it depreciates sharply.

 

Published on March 17, 2021

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