There is no disputing that the domestic economy has been decelerating and the jury is still out on the effectiveness of the measures initiated by the Centre to stem the slowdown. Even as all the macro data points have been flashing either red or amber, there is one part of the economy that appears on reasonably steady ground — forex reserves.
While growth came under severe stress following the credit contraction in the aftermath of the IL&FS crisis, forex reserves have been steadily increasing since last October; recording a growth of 14 per cent since then. At $447 billion now, the reserves are the highest ever.
This is quite comforting for the rupee, since it means that the central bank has sufficient funds in its coffers to protect it. This was evident in August this year, when the central bank sold close to $10 billion to stop the rupee from sliding past 73 against the greenback.
There are two important factors that have contributed to the accretion of reserves. One, the balance of trade has been largely under control over the past year. Trade balance in October 2019 was over 40 per cent below the corresponding month of 2018. This was largely due to benign crude oil prices; which has been hovering between $50 and $60 a barrel since this June. Imports were consequently down sharply, though petroleum product exports were also impacted. Slowing global trade has also played a part in pegging back the overall trade deficit; thus warding off reserve erosion.
Another factor that helped was the surprisingly strong inflows in the capital account. Foreign direct investments between April and June 2019 was up 28 per cent in dollar terms compared with the same period last year. This is a good rebound from the tepid year-on-year growth of 2 per cent in FY19. Despite concerns over slowdown in global growth due to the ongoing trade war, Brexit and geopolitical uncertainties, money has been invested in India.
There is an even more dramatic turnaround in foreign portfolio flows since the beginning of FY20. Portfolio flows into equity was ₹34,354 crore, while flows into debt was ₹31,490 crore, so far this fiscal year. This contrasts sharply with total FPI outflow of ₹38,930 crore in 2018-19. These numbers would be quite comforting to policy-makers as they show that foreign investors are willing to put money into the Indian equity market even as other markets turned volatile this calendar. Relatively superior interest rates on Indian debt, coupled with a stable rupee appears to be attracting foreign investors to debt as well. This would imply that the RBI has some room to move rates a little lower without disrupting flows too much.
Another component of the capital account, inward remittances from NRIs, was 26 per cent lower in the April-September 2019 period compared to the same period last year. This is possibly due to the stress in the Middle East. But with the Indian diaspora doing quite well in the US, it is likely that the flows will continue to grow in the coming years. According to OECD, India tops the list of countries with the highest inward remittances.
Asset price movement
While there have been periods when a sharp decline in dollar value or price of gold has dragged the forex reserves lower, it was smooth sailing on this front over the past year. In the first quarter of FY20, changes in the valuation of assets contributed $3 billion to reserves.
The 15 per cent rally in price of gold since the beginning of 2019, on increasing demand for safe havens, is partly responsible for this. Value of India’s gold reserves is up 32 per cent between September 2018 and November 2019. The US dollar, that forms a major chunk of the foreign currency assets, has also been steady, despite the Federal Reserve going slow with its monetary tightening.
But more important than the above are the USD-INR swap auctions conducted by the RBI this calendar. The central bank conducted two auctions of $5 billion each for tenor of three years in March and April this year. While these helped boost durable liquidity in the system, they also reflect in the forex reserves, boosting the same by $10 billion.
The central banks has also been making the most of the capital inflows over the past few months to add to its kitty. The RBI’s interventions have not only boosted reserves, they have also helped keep the rupee from appreciating sharply. The RBI has net purchased $22 billion as part of its market intervention in 2019.
The only sore point in the external account is the sharp growth in external commercial borrowings. The Centre and the RBI have been trying to coax Indian corporates to access international markets for their financing needs given the lower borrowing cost overseas and the tight domestic liquidity. But this has resulted in sharp increase in short-term trade related credit.
Keep up the momentum
The forex reserves can currently cover 8.7 months of imports. While this is comfortable, they fall short of the 10 month of imports that is more desirable. Of greater worry is the fast growth in external debt which can make servicing the debt difficult, going ahead. Debt-service ratio that measures export earnings against interest and principal payment on debt, is down to 5.8, from 8.8 in 2016.
These numbers show that the Centre needs to keep up its efforts to bolster forex reserves. With the US and China blowing hot and cold over the trade war, uncertainty remains.
Speculative run on the rupee due to offshore trading in the currency is also a threat.
The Centre, therefore, needs to continue wooing foreign investment into the country. The recent corporate tax rate cut will definitely help in encouraging FDI into the country. Improving the ease of doing business further is also exigent. Besides simplification of the processes in setting up and doing business, unnecessary flip-flops on policies should be avoided.
Above all, the RBI should continue to ensure that the rupee is not unduly volatile. Currency movement is one of the critical factors considered by debt investors.