Here’s why India, Asia’s third-largest economy, needs to increase its record-breaking foreign exchange reserves

Currency stack hit record high last month as RBI absorbed dollars flowing in as foreign investment

Raising India’s foreign exchange reserves to over $ 600 billion may not be enough to meet the challenges facing Asia’s third-largest economy, some central bankers and economists say. The stack hit a record high of $ 608 billion last month, mainly thanks to the Reserve Bank of India absorbing the dollars flowing in the form of foreign direct investment, as well as the booming stock market of the country. The treasury could help reassure investors and rating companies about the government’s ability to meet its debt obligations despite the deteriorating fiscal outlook.

But the overall figure hides some shortcomings, analysts, including central bank researchers led by Deputy Governor Michael Patra, say. “Levels are often misleading,” Patra and his RBI colleagues wrote in the latest central bank bulletin.

Here are five charts that show why India is vulnerable to external shocks despite record reserves:

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While the battery – the fifth in the world after China, Japan, Switzerland and Russia – is sufficient to cover 15 months of imports, it is well below Switzerland’s reserves – which can pay for 39 months of imports. imports – Japan’s 22 months and Russia’s 20 months, according to RBI researchers.

As the economy recovers from the second wave of the pandemic, demand for imports is expected to increase in the coming months.

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Although India’s foreign reserves are increasing, the economy still has a negative net international investment position, which means that foreigners hold more Indian assets than the nation holds foreign assets. The negative figure is an imbalance that the central bank will want to correct, according to Radhika Rao, an economist at DBS Bank Ltd. in Singapore.

“This imbalance is likely to keep the central bank keen to further strengthen the buffer, also providing key ammunition to combat the short-term volatility of global developments,” Ms. Rao said.

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Countries with chronic current account deficits tend to rely on foreign capital and debt capital for their financing. While short-term foreign debt as a percentage of reserves declines steadily, Indian policymakers are often concerned about the country’s exposure to external shocks.

Investments in debt, especially those that hunt high yielding emerging assets like those from India, can change suddenly and cause volatility in local asset markets, especially towards the partially convertible rupee.

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Foreign inflows have undoubtedly contributed to the constitution of national reserves. But the good times may come to an end soon as the US Federal Reserve prepares to withdraw some of its extraordinary monetary stimulus, potentially triggering capital outflows from emerging markets.

A recent working paper released by the Bank for International Settlements showed India to be vulnerable to Fed monetary tightening, with cash outflows potentially impacting financial conditions and the economy as a whole. The paper showed that when the United States tightens monetary policy, the financing conditions of Indian non-financial corporations deteriorate as their net worth declines and access to credit deteriorates.

At the same time, a weaker rupee combined with higher US interest rates leads to a slowdown in both domestic credit and the business cycle, according to the BIS document.

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Raising reserves is a priority for the central bank, Governor Shaktikanta Das said last month, citing the RBI’s efforts to stabilize financial market and liquidity conditions so that monetary policy remains independent to “pursue the national objectives “.

Analysts say Mr Das’ comments imply that the RBI is trying to manage the so-called “Impossible Trinity” – by maintaining the independence of monetary policy, allowing a constant flow of foreign capital and keeping the currency stable. – by choosing to pursue independent rates. Politics. This determination will inevitably be put to the test in the months to come.

“The Fed’s next round of taper and rise thereafter will test the defense,” DBS Bank’s Mr. Rao said.

(Except for the title, this story was not edited by NDTV staff and is posted from a syndicated feed.)


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