Forex Reserves Fall Over $50 Billion From Peak as RBI Defends Rupee

Synopsis

India's foreign exchange reserves shrank for the fourth straight week to $734.6 billion as of 2 October from a record high of $785.71 billion on 4 September. The RBI has been engaged in the selling of dollars in the spot market and has been engaging in selling/buying swaps to absorb excess rupee liquidity. But the rupee has remained at its record low, weighed down by oil prices, US interest rates and foreign capital outflows.

The foreign exchange reserves of the Reserve Bank of India (RBI) dipped by $734.6 billion for the fourth successive week to $734.6 billion, according to a footnote in the statement by the RBI Governor Sanjay Malhotra.

The fall in numbers

The reserves were at a record high of $785.71 billion as of 4 September, and have fallen by around $51 billion in less than five weeks. In the week ended 18 September, they fell $14.88 billion to $765.9 billion, and again for the next week, to $747.56 billion on a loss of $18.34 billion.

The week 2 October saw another drop of approximately $13 billion, according to the Veritas's estimate based on these figures. Foreign exchange reserves declined in what was the largest-ever recorded decrease in India

Causes of the decrease of reserves.

The drawdown is linked to RBI's intervention in the dollar spot market to smoothen the rupee's fall, as well as sell/buy FX swaps for sucking up excess liquidity. Information on the separation of these tools has not been found for the RBI. Despite the support, the rupee has kept on getting weaker, being pushed by high oil prices, higher yields on the US Treasury bonds.

When the central bank sells dollars for rupees today and buys them back at a later date. This will temporarily dry up rupee liquidity, but not dollar reserves.

The Governor's view

When queried about the currency during the press conference after the policy, Mr Malhotra said that markets can be irrational in the short run and quoted a few estimates, including the real effective exchange rate, that did not show the rupee to be overvalued. The currency on Wednesday dropped by almost 0.5 percent to 96.8450 per dollar, near its record low of 96.96.

Why it matters

Foreign exchange reserves serve as buffer stocks for import bills and external debt payments, and for curbing disorderly movement of the currency.

Changes in valuation also affect reserves, since foreign asset holdings and gold holdings are re-valuated in line with market prices; not all changes are necessarily a sign of intervention. The rate of withdrawals to buffer volatility will be one of the important market indicators in the near future.

What next

Reserve data is released every week by the RBI on Fridays. Any further drop would continue the trend of negative dollar demand from oil consuming countries, whereas a reduction in demand for dollars from the external sector, or a reversal in foreign demand, would relieve the pressure.