Forex reserves surge to an all-time high of $538.191 billion

K Ram Kumar Mumbai | Updated on August 16, 2020

The rise is mainly due to lower trade deficit and higher foreign direct investment inflows, says Madan Sabnavis, Chief Economist, CARE Ratings

India’s foreign exchange reserves soared about 3.4 times in the March-end 2020 to August 7, 2020 period vis-a-vis the year-ago period and counting.

The reserves in the aforementioned period swelled by $60.384 billion against $17.701 billion in the year-ago period.

At this rate, in just the first five months of the current financial year, the forex reserves will likely bulk up by as much as what was added in the whole of last financial year (FY20). In FY20, the reserves jumped by $62.691 billion.

The reserves touched a new record high of $538.191 billion as on August 7, 2020. India now holds the fourth largest forex reserves in the world.

Lower trade deficit, higher FDI push up reserves

Madan Sabnavis, Chief Economist, CARE Ratings, opined that the forex reserves have jumped mainly due to lower trade deficit and higher foreign direct investment (FDI) inflows.

“Essentially, the trade deficit has come down, and FDI has gone up. Lower trade deficit also means lower current account deficit. That is the main reason why the forex reserves are going up,” he said.

Sabnavis observed that the implication of the increase in reserves is strengthening of the currency based on fundamentals (balance of payments) and external factors (essentially, what is happening to the dollar).

Brickwork Ratings (BWR), in its report ‘Drishtikone’, attributed the sharp rise in forex reserves to jump in gold prices, which accounts for 6 per cent of the total reserves.

Underscoring that forex reserves come with a cost, Sujan Hajra, Chief Economist, Anand Rathi Securities, in a report, cautioned: “While this (forex reserves) provides huge resilience to India’s external sector position, with low (often less than 1 per cent) yield, the cost of holding high forex reserves is rising.”

This would make a progressive accumulation of forex reserves costly for the country, especially since the reserve levels are already high by all measures, he added.

Rupee strengthens

In the backdrop of dollar inflows and weakening of the greenback, the Rupee strengthened from 75.60 to the Dollar as on March 31, 2020 to 74.93 as on August 7, 2020.

Last week, the Rupee closed a shade stronger at 74.90 on August 14 vis-a-vis previous weekend’s close of 74.93.

BWR’s report emphasised that abundant forex reserves, which gives much-needed comfort to absorb external shocks, will help the RBI to intervene in the forex market whenever required. The credit rating agency expects the Rupee to remain at 75-76 per Dollar in the current fiscal.

According to the International Monetary Fund, foreign exchange reserves are held by a country in support of a range of objectives including to support and maintain confidence in the policies for monetary and exchange rate management, including the capacity to intervene in support of the national or union currency.

Further, the reserves are aimed at limiting external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed. And in doing so, provide a level of confidence to markets that a country can meet its external obligations. It also demonstrates the backing of domestic currency by external assets.

Published on August 16, 2020

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