InvestorQ : Why are brokerages and markets so worried about India’s falling forex reserves? Is it really a worry for India?
Anamika Sodhani made post

Why are brokerages and markets so worried about India’s falling forex reserves? Is it really a worry for India?

Angel dcosta answered.
3 weeks ago

India’s forex reserves have bene falling for quite some time. Recently, Jefferies India, in a report had highlighted that India should be more worried about its falling forex reserves. For the week ended 02-Sep, the forex reserves fell by another $8 billion to touch the $553billion mark. At the start of the current year, forex reserves stood at $647 billion and in the last 9 months the reserves have fallen 18%. Incidentally, this is the lowest level of forex reserves since October 2020. Now even economists are getting tad worried about falling reserves.

There is a counter argument to this theory too. It says that countries like Russia, China and Saudi Arabia also experienced a very rapid meltdown of forex reserves when the crisis struck these economies. In these countries, the fall in forex reserves was anywhere between 25% and 35%. However, the comparisons are not really justified. China, Russia and Saudi Arabia run huge merchandise trade surpluses and their exports can quickly create a forex chest. On the other hand, India runs a $28-30 billion trade deficit every month.

The reason economists are worried is that the rapid fall in forex reserves happened amidst dwindling foreign portfolio flows from the FPIs. FDI flows are not as quick as the previous years. FPIs sold nearly $33 billion of Indian equities between October 2021 and June 2022. At the same time, the rupee is falling sharply and the RBI is trying hard to defend the rupee. RBI tried to defend the rupee around 76/$ levels, then 78/$ levels and now at 80/$. This is done by selling dollars, so it costs forex reserves to defend the rupee at existing levels.

RBI also is in a quandary here. They cannot allow the forex reserves to dwindle beyond a point. At the same time, if the rupee is allowed to decisively breach beyond the 80/$ levels, it could trigger a lot of stop losses and forex risk management triggers for Indian companies. That will only end up weakening the rupee further against the dollar. With Fed still hawkish, hardening of the dollar will lead to further weakness in the rupee. RBI will continue to put in effort to defend the rupee and the levels will keep going higher. That is the worry.

The reserves may be nowhere close to the crisis levels of 2013, but India has been funding its forex reserves through portfolio flows. In the last few months, these have been very erratic. The issue would be if current account deficit (CAD) touches 4% to 5% of GDP in FY23, and that is perfectly possible. Most fund managers are worried about an FPI run on debt if other bonds are more attractive. A run on debt can trigger a rapid fall in the rupee and that is where RBI defending the rupee can lead to a sharper fall in the forex reserves.