India’s foreign-exchange reserves surpassed Russia’s to become the world’s fourth largest, as the South Asian nation’s central bank continues to hold and store dollars to cushion the economy against any sudden outflows despite a drop in its international investments in dollar terms.
On March 13, the RBI said the country’s foreign currency holdings fell by $4.3 billion to $580.3 billion as of March 5, while edging out Russia’s $580.1 billion pile. Currently, in the International Monetary Fund (IMF) table, China has the largest reserves, followed by Japan and Switzerland. At present, India has enough reserves to cover roughly 18 months of imports. Experts say this is due to the rare current-account surplus, rising foreign direct investment and inflows into the local stock market.
Analysts say a strong reserves position gives foreign investors and credit rating companies added comfort that the government can meet its debt obligations despite a deteriorating fiscal outlook and the economy heading for its first full-year contraction in more than four decades.
"India's various reserves adequacy metrics have improved significantly, particularly in the last few years,"
Kaushik Das, chief India economist at Deutsche Bank,
"The healthy FX reserves position should give enough comfort to RBI for dealing with any potential external shock-driven capital-stop or outflows in the period ahead." Forex or foreign exchange reserves are essentially assets held by the central bank in foreign currencies as a reserve. They are usually used for backing the exchange rate and influencing monetary policy. In the case of India, our forex reserves include dollars, gold, and the International Monetary Fund’s quota for Special Drawing Rights. Most of the reserves are usually held in US dollars given the currency’s importance in the international trading and financial system. Some central banks also hold reserves in British pounds, euros, Chinese yuan, or the Japanese yen, in addition to their US dollar reserves. These foreign reserves are tremendously important because All international transactions are settled in US dollars and are therefore needed to support our imports. More importantly, they are needed to support, maintain confidence for central bank action, whether monetary policy action or any exchange rate intervention to support the domestic currency. It also helps limit any vulnerability because of a sudden disruption in foreign capital flows, which could happen during a crisis. Holding liquid forex thus provides a cushion against such effects and gives the confidence that there would still be enough forex to support the country’s crucial imports in case of external shocks.
The increase in India’s reserves is an outcome of an increase in FDI. This comes along with FIIs pouring money into markets expressing confidence in the economy. The increase in FDI, however, is primarily an outcome of the successful capital raise by Reliance Industries’ Jio Platforms amidst this global pandemic. Another reason is that a slowdown means lower domestic consumption, which implies lower imports. This coincides with low crude oil prices which further help on the current account front. Foreign investors had acquired stakes in several Indian companies in the last two months. According to the data released by RBI, while the FDI inflow stood at $4 billion in March, it amounted to $2.1 billion in April. After pulling out Rs 60,000 crore each from debt and equity segments in March, Foreign Portfolio Investments (FPIs), who expect a turnaround in the economy later this financial year, have now returned to the Indian markets and bought stocks worth over $2.75 billion in the first week of June. Forex inflows are set to rise further and cross the $500 billion as Reliance Industries subsidiary, Jio Platforms, has witnessed a series of foreign investments totalling Rs 97,000 crore. The sharp jump in reserves seen over the last nine-months started with the finance minister, Nirmala Sitharaman’s announcement to cut corporate tax rates on September 20. Since then the forex reserves have grown by $73 billion.
It is important to note that the increase in reserves does give India adequate cushion to combat external shocks. India is one of the few nations whose forex reserves are more than forex debt. The increase in FDI signals faith in the future of the economy, rather than a commentary on its present state. Lower imports are a result of lower domestic demand, but currently, it is due to the lockdown too. It is, therefore, difficult to consider the increase in reserves as a direct sign of a healthy economy.
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