Reserve Bank of India’s foreign exchange reserves declined by $ 2.676 billion to $ 593.279 billion in the week ended May 13. The weekly data showed that the fall was mainly due to a fall in foreign currency assets (FCA), a major component of the overall reserves, and a fall in its gold reserves.
FCA declined by $1.302 billion to $529.554 billion in the week. Gold reserves declined by $1.169 billion to $40.57 billion.
RBI data also showed that its forex reserves fell by $20 billion on a net basis in March due to increased dollar selling in the spot markets – the highest in a month.
There is a declining trend in RBI’s reserves. They fell by $1.774 billion to $595.954 billion in the previous week. A few months ago, in September, they were at an all-time high of $642 billion. As of May 6, reserves were below 10-month export cover, not a risky level but the pace of erosion is alarming.
While part of the disadvantages are that some non-dollar currencies held as reserves have lost value against the stronger dollar which is rising against most currencies, the RBI is also intervening in the foreign exchange market, in its own right. Spending dollars from reserves. Protect the rupee which has been falling steadily, and will continue to do so, even as RBI tries to control the slide to protect the rupee.
The rupee, which hit an all-time low of $77.80 last week, has been hitting new lows every few days over the past few weeks, as global capital moves away from emerging market economies like India for relative safety. The US financial system after the US Federal Reserve began raising interest rates and reversing its loose monetary policies. A narrowing of the interest rate differential between emerging markets such as the US and India will accelerate the return of dollar investors.
In these unavoidable circumstances, why is RBI spending foreign exchange so quickly? Fighting the depreciation of the rupee by aggressively sinking it into its reserves is a losing battle; RBI should allow the rupee to fall smoothly.
Given that the depreciation of the rupee is inevitable in these circumstances, the RBI should stick to its stated objective of ensuring that there is no undue volatility in the money markets. This should smooth out mudra movements. Trying to protect the rupee by selling the dollar is a losing proposition, when the dollar strengthens against not only the rupee, but most other currencies, as has been the case for some time.
Second, speculative currency trading is well aware of New Delhi’s ideological intolerance to ‘the weakening of the rupee’ and its tendency to view the foreign exchange rate as a measure of ‘national strength’.
Indeed, speculators armed with this knowledge had stormed the rupee in a series of fast-paced depreciation in 2018. RBI spent about $25 billion out of its $425 billion reserves between April and September 2018. Nevertheless, the rupee had gone from around 65 to a dollar to over 71 at the same time. RBI then intervened very selectively, perhaps recognizing the futility of opposing the slide.
RBI’s reserve was small then. Similarly, in a series of ‘taper tantrums’ in 2013, when the US Fed’s indication that it would end its massive quantitative easing policies sooner than expected, led to an outflow of dollar investments from emerging markets such as India, resulting in rupee depreciation. But one run. And RBI’s efforts to protect the rupee, falling to new lows amid speculative trading, had dented reserves below $275 billion.
While the rupee has fallen deeper than in 2018 and 2013 in this latest ongoing encounter, the relatively large size of reserves is a source of comfort. However, the Fed’s rate hike cycle has just begun and is likely to continue well into 2023, if not 2023. Therefore, RBI runs the risk of getting caught in a situation where it has tried and spent too much of its reserves too soon. To slow down the fall of Rs. Instead it should focus on reducing volatility.