The Centre’s response to the recent bout of weakness in the rupee has been surprisingly casual.
Widening trade deficit and sluggish export growth could put further pressure on the country’s forex reserves.
What are the risks and responses thus far?
While the RBI has maintained a stoic silence, the Finance Minister merely tweeted that India’s foreign exchange reserves are comfortable.
Going by the global standards, for the country’s forex reserves are indeed better than many other emerging economies to meet volatilities.
But given the changing global liquidity conditions and their impact on FDI and FPI flows (foreign capital), the present currency situation is a risk.
The situation gets further complicated due to the structural issues - “widening trade deficit, sluggish export growth and growing imports”.
It would therefore be better to acknowledge the challenges and think about corrective action rather than be in denial.
What is the situation with RBI’s forex reserves?
Taper Tantrum of 2013 and the subsequent widening of current account deficit eroded the forex reserves that the RBI had built till then.
Since then, RBI has been very cautious with currency reserves and had built strong buffers, which reached an all time high of $426 billion in April 2018.
Investments - Strong inflows from “Foreign Direct Investors” (FDIs) since 2013 had helped to a large extent in shoring up reserves.
But lately with less than 5% growth in 2018, FDI flows are already down from around 25% during 2015-16.
Foreign Institutional Investments (FII) is also likely to reduce with a net outflow of over 20,000 crores recorded this financial year.
The reduction in foreign inflows makes it difficult for the RBI to mop up reserves, and sustain the currency value.
Notably, in the three months from April to June 2018, the RBI has net sold $14 billion and the reserve levels have come down by about 10% thus far.
The import cover was 11.1 months in April 2018, but it is already down to 9.9 months currently and is likely to deteriorate further.
How is the action of U.S. Federal Reserve affecting capital supplies?
Foreign capital inflow into a country is a function of global liquidity conditions, which isn’t very conducive lately.
After pumping in trillions of dollars since the 2008 crisis, the Federal Reserve began shrinking its balance sheet since October 2017.
While this is reducing liquidity in global markets, the rate hikes from the Fed are making the cost of financing expensive.
Therefore global investors have less to spend and are reducing their investments in emerging markets including India.
“International Monetary Fund” (IMF) estimates that the Fed’s tightening can result in reducing flows into emerging markets by $35 billion a year.
How is the debt situation affecting forex?
Due the excessive liquidity in global markets after 2008, the country’s external debt has doubled from $224 billion in 2008 to $529 billion now.
Indian companies made the most of easy liquidity conditions overseas, increasing non-governmental external debt to 80%.
Notably, External Commercial Borrowings (ECB) now account for over one-third of the country’s total debt.
Repayment of those loans that reach maturity in the coming months is likely to drain more forex and it will also be difficult to repay these due to less liquidity.
