India’s Foreign Currency War Chest: USD 500 billion and Growing Forex Reserves

India’s Foreign Currency War Chest: USD 500 billion and Growing Forex Reserves

‘Forex Reserves War chest the biggest confidence booster for Foreign Investors and RBI.’

‘India has come a long way from the 1991 Balance of Payment crisis, wherein only Foreign Exchange Reserves were adequate to pay for three weeks of imports. With the present war chest of USD 500 billion and growing it has enough Forex for 1-year worth of imports and ability to deal with any contingency in terms of sudden outflow of foreign capital.’

The year 2020 has been a year that no one would forget in centuries to come. With the spread of COVID-19 across the globe world economy has taken a big hit. The fine balance between life and livelihood is what most Governments around the world are jostling with. India has been under one of the most severe lockdowns compared to the other parts of the world resulting in millions of SMEs shutting down and millions of people losing their jobs. It is estimated that the Indian economy is going to shrink around 5% this year and for the first time in 4 decades there would be a negative GDP growth in India. 

Since the onset of the pandemic there has been support from the RBI as well the Government on the monetary and fiscal side respectively in order to revive the Indian economy. With this kind of increased government spending and support provided for the economy, the fiscal deficit is bound to slip and it is estimated that the deficit could be as high as 7%. With these circumstances, Moody’s downgraded the sovereign rating of India with negative outlook. 

Sovereign rating is very significant for foreign investors when they are looking at investing in a certain country. The only silver lining that the Indian economy has witnessed in the last few months is the increase in Foreign Exchange Reserves. India has a Foreign exchange reserve in excess of USD 500 billion which gives a lot of comfort to the Reserve Bank of India - the custodian of foreign exchange in India and the Government of India and also the Foreign Investors who are looking at the Indian markets in terms of FDI as a long term investment destination as well as investments in the equity and debt markets in India. 

In the month of May 2020, the forex reserves increased by approximately USD 12.5 billion to reach an all-time high level of USD 500 billion. This is a big shift in overall macro-economic environment. Since liberalization the Indian economy has come a very long way from the Balance of Payment crisis faced in 1991, wherein India’s foreign exchange reserves could only support three weeks of imports and the Indian Government had to pledge gold to raise adequate forex. At present India can support 1 year worth of imports. From a forex reserves of USD 5.8 billion in March 1991, journey to a level of USD 500 billion has been long and hard for the Indian economy. 

Forex reserves are external assets in form of Gold, SDR (Special Drawing Rights of International Monetary Fund), foreign currency assets in various currencies like the USD, GBP, EUR, JPY and CNY. The forex reserves comprised of USD 464 billion in various foreign currencies; approximately USD 32 billion in Gold, USD 4 billion in SDR and reserves with IMF. In terms of Gold, India has 653 tons of Gold as on March 2020, of which 360 tons is being held overseas in custody of Bank of England and Bank of International settlement. The remaining gold is held locally by the RBI. Of the total foreign currency reserves held in various currencies, approximately 50% is held in USD, much lower than other emerging countries which hold on average almost 57% of their reserves in USD and drastically lower than other developed nations which hold almost 64% of their reserves in USD. 

Of the total portion of USD 464 billion, 64% is held in securities like Treasury Bills of foreign countries mainly the USA. 28% is deposited in foreign Central Banks and 7.4% is deposited in commercial banks abroad. With this large war chest in terms of foreign currency reserve, gives enormous amount of comfort to the RBI as well as the Government of India to manage the overall monetary as well as fiscal policy. The rising reserves have helped rupee to strengthen against the USD. At present the foreign exchange reverse to GDP ratio is around 15% which gives a lot of comfort to even foreign investors and rating agencies thereby signaling a strong economic outlook in the medium and long term for India and one of the most promising developing economies in the world. 

With India gaining significance at a world stage, the ability for Indian nationals to invest abroad is the key factor in a globalized world. At present an Indian national can remit USD 250,000 per person per year from India. With the increase in forex reserves there could well be an increase in this amount in the next couple of years thereby giving flexibility for India to invest in markets and assets overseas. The RBI uses the forex reserves to control the movement of the INR against various foreign currencies. RBI sells USD when the INR weakens and buys USD when the INR strengthens. At present the RBI has been buying USD and when the RBI buys USD it realizes an equivalent amount in INR, this excess liquidity is used to support the economy on the monetary side in terms of LAF (Liquidity Adjustment Facility) operations. 

There has been a risk-off environment in terms of financial markets in the month of March 2020, wherein Foreign Investors withdrew almost INR 60,000 crores from the Indian markets. However in April and May 2020 there has been substantial investment which has come in. The JIO investment would come mostly in the month of July 2020. FPI (Foreign Portfolio Investors) did bring in approximately USD 2.6 billion during the week of 29th May to 5th June 2020 but to say net exports or net services were over USD 5 billion which is not possible, hence the magical figure of USD 8 billion as inflow needs to be looked at. 

The significant aspect is almost 50% of the foreign currency reserves held by India are in non-USD. During the week of 29th May–5th June 2020 USD weakened against the EUR by almost 2.3%, thereby revaluation of the reserves by almost 50% non-USD comes to around USD 5.2 billion. Hence with the amount of money being printed by the US Fed, the USD would weaken further, thereby resulting in the value of the non-USD reserves in other currencies like EUR swelling up thereby the revaluation of the total forex in India is increasing with time. 

With USD 500 billion as forex reserves in India, it gives a lot of confidence to RBI and Government of India along with the foreign investors that India has a stable economic outlook and good amount of foreign exchange reserves, making it a stable investment destination for foreign investors. With FPI and long term investment flowing in companies like JIO, the reserves will continue to swell which would further be assisted by a weakening USD. Hence it’s only a matter of time that the Forex reserves would touch USD 600 billion in India. 

_Farzan Ghadially.