Concern Grows Over India’s Forex decline

India’s foreign exchange (forex) reserves have seen a noticeable decline, sparking concerns about the country’s economic stability. As of December 20, 2024, the reserves stood at $644.39 billion, a drop of $8.48 billion from the previous week, marking their lowest level in nearly six months. This downward trend can be attributed to several interconnected factors. One key contributor is the Reserve Bank of India’s (RBI) market interventions to manage volatility in the Indian rupee. The currency recently hit a record low of 85.12 against the U.S. dollar, prompting the RBI to sell dollars from its reserves to stabilize the rupee. While these actions aim to control fluctuations, they have significantly depleted the reserves. Additionally, a widening trade deficit has exacerbated the situation. In November 2024, merchandise exports fell by 4.9% year-on-year to $32.11 billion, while imports surged by over 27% to $69.95 billion. This growing imbalance between exports and imports puts further pressure on forex reserves, as more foreign currency is required to pay for imports. Foreign portfolio outflows have also played a significant role in the depletion of reserves. On November 28, 2024, investors withdrew approximately $1.4 billion from Indian equities. This capital flight reduces foreign currency inflows, compounding the strain on reserves.

Global economic conditions are another factor influencing the decline. A robust U.S. dollar, coupled with economic challenges in major economies like China, has led to the depreciation of regional currencies, including the Indian rupee. The offshore Chinese yuan’s weakness has particularly impacted the rupee, necessitating RBI interventions that further drain the reserves. Lastly, India’s banking system is grappling with a significant liquidity deficit, which stood at 2.43 trillion rupees as of December 23, 2024. This shortfall, driven partly by the RBI’s forex market interventions and tax outflows, poses challenges for monetary policy transmission and economic stability. The ongoing decline in forex reserves has broader implications for India’s economic health, potentially undermining investor confidence and limiting the country’s ability to weather external shocks. To address this issue, India needs to prioritize export competitiveness, attract sustainable foreign investments, and carefully manage import demand. Allowing the rupee to adjust naturally in response to market forces could also reduce the need for aggressive interventions, preserving forex reserves in the long run. Well, while the RBI’s efforts may be to stabilize the rupee is justified, India must adopt a holistic approach that balances immediate interventions with structural reforms to halt the decline in forex reserves and ensure economic resilience.