India’s foreign exchange reserves have fallen by around $110 billion from a peak of $642 billion in September last year, and although this is largely due to falling asset values in dollars and other currencies, another important reason is central bank intervention in the currency. market to protect the rupee.
The local unit fell around 11% against the US dollar in 2013, a drop it has already matched so far this year, with most market participants expecting further declines by now. the end of 2022.
To defend the rupee, the Reserve Bank of India dipped into its foreign exchange reserves. It has sold $43.15 billion net since the start of 2022, including $4.25 billion in August, according to the latest available data released on Monday.
“It would be important to rebuild foreign exchange reserves for sure. There will be urgency because the fundamentals are also unfavorable,” said Madan Sabnavis, chief economist at Bank of Baroda.
The RBI in July announced some measures to liberalize foreign exchange inflows, including giving foreign investors access to more public debt and banks more leeway to raise more deposits. to non-residents.
But these measures are unlikely to prove as effective now as they were in 2013.
In 2013, the RBI offered to exchange US dollars that banks had raised through Foreign Currency Non-Resident Deposits (FCNR) or foreign currency funding for Rupees at concessional rates.
It traded FCNR deposits, with a maturity of three years or more, at a fixed rate of 3.5% per annum, about 3 percentage points lower than market rates at the time, while it traded FX funding at 1 percentage point below the market. rates.
These two trading windows had brought in around $34 billion at a crucial time, including $26 billion through the FCNR channel alone.
But these methods are unlikely to be so successful now.
“The FCNR filing path may not be as effective this time around, including for reasons such as a narrower US-IN rate spread and less aggressive rate hikes in this cycle compared to 2013,” said said Radhika Rao, senior economist at DBS Bank.
This time around, with Indian 3-year bond yields at 7.5% and US yields at 4.5%, the 3% spread is unlikely to help investors turn a profit on an entirely hedged, given that the current hedging cost is around 6.5% to 7%. . Profits are unlikely even if the RBI offered a rebate window, which it has not done so far.
“On a fully covered basis, a similar level of subsidy will not suffice. Either domestic tariffs have to rise significantly or the RBI will have to increase the subsidy to make things work,” said Vivek Kumar, senior economist at QuantEco Research.
To add to the problems, India’s economic fundamentals have also weakened.
The current account deficit has widened and is expected to remain above 3% of gross domestic product for the current fiscal year, ending in March 2023.
With capital flows also volatile, economists expect the balance of payments to turn negative, which will further deplete reserves.
And although reserves at current levels are sufficient to cover more than eight months of imports, analysts say a sustained depletion could raise concerns.
“A drop below eight months of import cover (around $500 billion) could start to get market attention if the current account deficit remains above 3% of GDP,” QuantEco’s Kumar said.
“A panic situation provoking a forceful political response could emerge if reserves hit six months of import cover, or about $380 billion.”
Analysts said while short-term fixes could provide intermittent relief, policymakers should continue to focus on strengthening structural macroeconomic buffers.
Bank of Baroda’s Sabnavis has suggested floating sovereign bonds, like Resurgent India (RIB) India Millennium Deposit (IMD) bonds in the past, to help boost foreign exchange reserves.
“Such measures can directly bring in money,” he said.
Sabnavis said the rupiah could weaken further towards near-term levels of 82-83 and fall to 84 if the dollar continues to strengthen. The local unit is currently at 82.28 to the dollar.
“It’s hard to really gauge the level, and expectations tend to adjust depending on how RBI reacts.”