Echoing former Reserve Bank of India (RBI) governor C. Rangarajan, Ashima Goyal, a member of the central bank’s technical advisory committee, has called upon RBI to use foreign currency reserves to support the rupee.
However, as data for 1 June shows, India’s foreign exchange reserves fell for a sixth straight week. While the total figure of $285 billion looks comfortable enough, note that the cover they provide is dwindling. In 2007, the forex kitty amounted to three times the external financing requirements (short-term debt plus current account deficit), according to Citigroup estimates. That has fallen to 1.7 times for 2012.
Note that the country has seen a 12% decline (about $35 billion) in forex reserves from their peak in early September. Of course, this decline is not due to RBI’s intervention alone. For example, during September-April, while forex reserves fell about $25 billion, the central bank sold about $20 billion of the US currency. This suggests that the rest of the drop was owing to depreciation in other foreign currencies held by RBI.
Part of this 12% erosion would be due to the recent surge in the dollar against other currencies. Note that the dollar index gained 5.3% in May. This decline is unparalleled in recent history, except during the North Atlantic financial crisis when reserves fell by more than one-fifth. On that occasion, a fair portion of reserves were clawed back during the latter half of 2009. But now, refilling this tank could prove a bit more difficult.
To be sure, there is optimism from sharply lower prices of crude oil and declining gold imports, which has prompted economists to prune their estimates for this fiscal’s current account deficit. However, that alone might not be enough for reserves to be topped up.
Part of the reason why reserves went up in 2009 was strong capital inflows, particularly into equity. In other words, global markets were back in the “risk-on” mode. It also helped that crude prices were around $70 to start with, even if they increased, and the current account deficit was within manageable limits.
Now, as the drop in commodity prices shows, markets are in a “risk-off” mode. Given the uncertainty around the Greek exit, it may continue for some time, thereby painting a bleak picture for the capital account. Thus, even if the current account improves slightly, the danger is that capital inflows might shrink, especially with deleveraging abroad.
India’s current policy environment only makes conditions worse. Therefore, a further drawdown in reserves seems likely, unless RBI issues dollar bonds. But then, borrowing in foreign currency is sure to increase risks.
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PDF by Ahmed Raza Khan/Mint