While the fall of the rupee has been relatively moderate, the pace at which India’s foreign exchange reserves are dwindling is a cause for concern

While the fall of the rupee has been relatively moderate, the pace at which India’s foreign exchange reserves are dwindling is a cause for concern

The rupee’s weakening exchange rate and the pace at which India’s foreign exchange reserves are dwindling are back in focus. The Ukraine crisis and the U.S. Federal Reserve’s aggressive monetary tightening have led the rupee to depreciate past the 82 per dollar mark, while India’s reserves have shrunk to a two-year low.

Reserves include foreign currency assets, gold, special drawing rights with the International Monetary Fund, and reserve tranche position. These external assets, controlled by the monetary authority, are used to absorb shocks during times of crises; provide confidence to the market that external obligations can be met; and build capacity for intervention in foreign exchange markets.

Forex reserves are a crucial indicator of a country’s economic health and its import capacity. As per a Bloomberg report, dwindling forex reserves have led to a shortage of dollars in many import-reliant economies. As a result, countries that are dependent on overseas food purchases are finding it hard to pay for commodities such as rice and wheat.

The Fed’s steep increases in interest rates have made the dollar more attractive. Consequently, the dollar index has soared by 15% this year – a two-decade high – while other currencies have declined.

Strong currencies such as the pound (-21.62%) and euro (-17%) have also weakened against the dollar. The Japanese yen, considered a safe haven, has slipped to a 24-year-low. Several currencies, like the rupee, have touched their all-time lows, but the fall of the rupee has been relatively more moderate. Chart 1 shows the change in a currency’s value against the dollar in 2022 (data till October 7).

Chart appears incomplete? Click to remove AMP mode

Central banks across the world have stepped in to defend their currencies. As a result, reserves have depleted by more than $100 billion each in China, Japan, Switzerland and Singapore. While Singapore’s reserves saw the sharpest decline in percentage terms, China’s fell the most in absolute terms. As the yen breached the 145 per dollar mark, Japan’s reserves fell by $54 billion in the last one month. Table 2 lists the drop in reserves in absolute terms and the percentage change in 2022. It also lists the total reserves available.

In the last nine months, India’s reserve stockpile fell by $97 billion. This is significantly higher than the drawdown of reserves during the 2008 global financial crisis ($37.3 billion) and the period of the taper tantrum in 2013 ($16.6 billion). A crucial difference between this crisis and the other two has been the size of India’s reserves. While India has the fifth-highest reserves in the world, the pace at which they are depleting is causing concern. Reserves as of September 2022 were equivalent to nine months of import cover compared to more than 15 months in September 2021. Chart 3 shows the month-wise level of India’s forex reserves in 2008, 2013 and 2022.

India’s reserves are by and large a product of capital flows (funds through foreign investments, borrowings) and not so much from the current account (net income earned through exports of goods and services and remittances), which is currently in deficit. As foreign investments eased, accumulation in India’s foreign reserves also dropped.

With the dollar strengthening, the value of the euro, pound and yen (also part of India’s foreign reserves) took a beating. This too led to a reduction in India’s reserves. This is called a valuation loss. Chart 4 shows the change in India’s forex reserves due to two factors — through balance of payments (sum of India’s capital flows and current account deficit) and through valuation loss/gain.

Source: IMF, RBI

Also read: Data | Why the rupee is under pressure — explained in seven charts

Source link

By Dipak

Leave a Reply

Your email address will not be published. Required fields are marked *