RBI should continue to build its forex reserves

| Updated on July 08, 2020

This will be useful if global financial conditions deteriorate further, causing turbulence in currency markets

A bright spot in the current gloomy economic scenario is the foreign exchange kitty crossing the $500-billion mark recently. It is welcome that the RBI is trying to add to its reserves, which will be useful if global financial conditions deteriorate further, causing turbulence in currency markets. The central bank was able to increase its reserves by $79 billion over the past year and by $29 billion since the beginning of this fiscal year. While the dollar-rupee swap auctions conducted in March and April this year have helped increase reserves to some extent, a couple of other unplanned and somewhat fortuitous developments are behind the increasing reserves — rising external commercial borrowings and an unexpected trade surplus. These factors also contribute to making the reserves situation quite vulnerable to fluctuations.

With global central banks pumping in enormous amount of money into the global economy and moving interest rates lower, Indian companies have found it easier to raise funds overseas at cheaper cost. ECBs raised in FY20 were 127 per cent higher compared to FY19. In the first two months of this fiscal, corporates had already borrowed over $2 billion. Increased overseas borrowing has downsides — corporates can struggle to roll over the loans if the rupee continues depreciating or if the interest rate cycle overseas turns adverse. The favourable trade balance is also not something to cheer about as it has been caused mainly by declining demand. Merchandise imports were sharply lower in April and May this year, in line with contraction in global trade. Once domestic demand revives with the economy unlocking, demand for petroleum and other products is likely to revive, causing pressure on the trade balance once again. On the other hand, foreign portfolio investments have not been too robust in 2020 with outflow from equities amounting to around ₹21,000 crore while debt outflows have been over ₹1,00,000 crore. While FPIs have turned net buyers in equities in May and June, they can turn net-sellers again if risk-aversion spikes, causing outflows from global emerging markets, if the pandemic does not abate by the end of this calendar. Similarly, while foreign direct inflows were strong until March — inflows in FY20 were 40 per cent higher compared to the previous fiscal year — direct investments are likely to be much lower in FY21 as businesses struggle to stay afloat amidst the pandemic. Remittances from NRIs are also likely to be lower with many overseas Indians witnessing pay-cuts or job losses.

The RBI is, therefore, being only prudent in its strategy to continue buying dollars. Not only does this add to the buffer, it also helps to keep the rupee weak, making it competitive in the export market in relation to its peers; the Indian currency is down 4.5 per cent so far this year. Other countries have also witnessed an increase in their forex reserves in the last two months, highlighting the fact that India too needs to be ready to face future turbulence.

Published on July 08, 2020

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