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India’s Strongbox of USD 500 Billion Foreign Exchange

India’s foreign exchange reserve has crossed the USD 500 billion mark. This is one upside for the economy. The level of reserves is enough to cover 13 months of imports. India’s reserve is now equivalent to nearly a fifth of the country’s gross domestic product. It’s also the fifth-largest in the world after China, Japan, Switzerland and Russia. (according to the International Monetary Fund) India’s fiscal outlook has deteriorated tremendously in the first quarter of F.Y. 21. But the ‘liquidity crunch’ can be kept in check now.

Why has the foreign exchange reserve become a strongbox?

India’s trade gap has narrowed to a 13-year low in May. Imports declined faster than exports. 

The RBI likely brought about $9 billion in the Forex market in the four weeks ended May 29, pushing up reserves to a record USD 493.5 billion.

There was a massive amount of inflow in the local stock market. Also, a huge influx of foreign direct investment in a unit of Reliance Industries Limited is one of the most important factors. RIL’s blue-chip platform JIO attracted investments worth USD 16 billion. In addition, inflows increased when Uday Kotak sold USD 919 million of its stake in Kotak Mahindra Bank to RBI. Net FDI flows constituted 51.7% of total capital flows in the year ended March 31, according to Deutsche Bank AG.

Due to lower dollar prices of crude oil, India is expected to save nearly USD 50 billion (INR 3.75 lakh crore) on its import bill. Even if the government doesn’t raise the excise tax, it hopes to garner an additional 1.6 lakh crore at the very least.

Data from the central bank show India’s external debt rose to USD 558.5 billion as of March 2020 from USD 474.4 billion five years ago. While the level has gone up, the ratio of foreign exchange reserves to overall debt has also risen to 85.5% from 72% in 2015.

Reasons why India is adding foreign exchange reserves

Maybe, India is guarding against a likely downgrade in India’s credit rating. It is also possible that the government wants to be ready for a bigger transfer of surplus to the revenue-starved government.

India’s equity markets have seen foreigners step up purchases. Unperturbed by Moody’s Investors Service’s downgrade of the nation’s ratin, USD 2.7 billion has been poured into stocks so far in the month of June. This is the most among big Asian markets. Foreign investors expect the economy to recover as the Government  gradually lifts the world’s biggest lockdown.

But the mop up is also a sign that the RBI sees the inflows as temporary and prone to reversal if growth fails to pick up. 

Current account deficit narrowed. But is this going to last?

India’s current account, the broadest measure of trade in goods and services, is likely to remain in surplus for the time being. But a recovery in imports might tilt the balance of India’s foreign exchange for the full year.

The demand has been hit hard in the last few months. But as the economy will revive, the need for capital goods and machinery will increase. The industrial sector needs to be brought back to pace. To add on, India receives its largest share of foreign exchange from export of services. And a weak global demand is likely to negatively affect services exports.

Data Source: Bloomberg

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