Rise in India’s Forex

Why in news?

Covid-hit India’s forex reserves jumped by a record $11.9 billion in the week ending July 31 to hit a fresh high of $534.5 billion.

How has India’s forex reserves risen?

The trend of rising foreign exchange reserves started after a sharp cut in corporate tax rates in September, 2019.
The investor sentiments turned weak after the budget announcement in July to impose higher surcharge.
Now, the investors are drawn to invest in the India as the government has decided to reverse its budget decision relating to higher surcharge impact on FPIs.

During the period between September 27, 2019 and July 31, 2020, India has added 25% of the reserves it had till September 20.
India has ranked fifth, behind China ($ 3,298 billion), Japan ($ 1,383 billion), Switzerland ($ 896 billion) and Russia ($ 591 billion).

The rising forex reserves have come as a breather as it can cover India’s import bill of more than one year.

What key factors has led to this rise in forex reserves?

FPI inflows: The FPI inflows has risen following the government’s decision in September 2020 to cut corporate tax rate.
Between April and December 2019, FPIs pumped in $15.1 billion.

Dip in crude oil prices: India’s oil import bill has declined since February 2020.
This is due to the global spread of coronavirus that roiled the stock markets and led to a crash in the Brent crude oil prices.
The crude accounts for almost 20% of India’s total import bill.
Brent crude oil prices fell to levels of $20 per barrel towards March end, and it dropped further and traded between $9 and $20 in April.
In January, Brent crude was trading between $60 and $70 per barrel.

Import savings: Lockdown across countries in response to the pandemic impacted global trade.
It has resulted in a sharp dip in import expenditure — electronics, gold and also crude oil prices among others.

FDI inflows: Between September 2019 and March 2020, FDI stood at $23.88 billion and in April and May it amounted to $5.9 billion.
A lot of FDI has also come in June and July too.
Thus FDI inflow has been a significant contributor to the rise in foreign exchange reserves.

Dip in gold imports: Gold import has dipped sharply in the quarter ended June 2020 following the high prices and the pandemic-induced lockdown.
According to the World Gold Council (WGC), gold imports plummeted by 95% to 11.6 tonnes in the quarter as compared to 247.4 tonnes in the same period a year ago.
This was due to logistical issues and poor demand.

What does the rising forex reserves mean?

It gives a lot of comfort to the government and the Reserve Bank of India in managing India’s financial issues at a time when the economic growth is set to contract by 5.8% in 2020-21.
It’s enough to cover the import bill of the country for a year.
It has also helped the rupee to strengthen against the dollar.
The forex reserves to GDP ratio is around 15%.
Reserves will provide a level of confidence to markets that a country can meet its external obligations.
It demonstrates the backing of domestic currency by external assets.
Adequate forex reserves should provide room for the RBI to cut rates and support recovery.

What does the RBI do with the forex reserves?

The RBI functions as the custodian and manager of forex reserves.
It operates within the overall policy framework agreed upon with the government.
The RBI allocates the dollars for specific purposes.
The RBI uses its forex kitty for the orderly movement of the rupee.
It sells the dollar when the rupee weakens and buys the dollar when the rupee strengthens.
Of late, the RBI has been buying dollars from the market to shore up the forex reserves.
When the RBI mops up dollars, it releases an equal amount in the rupees.
This excess liquidity is sterilised through issue of bonds and securities and LAF operations to prevent a rise in inflation.

Are forex reserves giving returns to India?

Only gold reserves have given big returns to India.
The RBI has not disclosed the actual returns from forex reserves.
But the experts estimate that India is likely to get only negligible returns as interest rates in the US and Eurozone are around 1%.
On the contrary, India could be facing a cost to keep the reserves abroad.
Out of the total foreign currency assets,

59.7% was invested in securities abroad,
33.37% was deposited with other central banks of other countries and the BIS and
7.06% comprised deposits with commercial banks overseas as of March 2020.

As at end-March, 2020, the RBI held 653.01 tonnes of gold.
Of these reserves, 360.71 tonnes is held overseas in custody with the Bank of England and the Bank for International Settlements.
The remaining gold is held domestically.
With gold prices shooting up around 40% to over Rs 55,000 per 10 grams this year, the value of gold holdings has shot up.

Source: Indian Express