scorecardresearchForex reserve dwindles. Time is ripe for shoring up forex kitty and boosting market

Forex reserve dwindles. Time is ripe for shoring up forex kitty and boosting market

Updated: 22 Nov 2022, 11:34 AM IST
TL;DR.
The RBI sold US dollars to the tune of $23.05 billion during the first five months of FY2023.
The build-up in reserves to the record high level was largely due to market purchases.

The build-up in reserves to the record high level was largely due to market purchases.

India’s forex reserves hit an all-time high of $642.453 billion in September 2021. As of November 11, 2022, it declined to $544.8 billion. Close to $100 billion of forex reserves was lost from its record high level. Does such a major fall in forex reserves concern the Indian economy and stock markets?

Interestingly, there is not much to feel happy about building up reserves to the record high level in September 2021 because the RBI purchased the US dollar to the tune of $130.73 billion from the open market during the period FY2020 to FY2022.

Therefore, the build-up in reserves to the record high level was largely due to market purchases rather than due to earnings from exports of goods and services or inflow of foreign capital through foreign direct investments or portfolio investments.

However, one should admit the fact that the RBI was smart enough to buy huge dollars from the markets before the rupee fell over 7% from the close of FY2022. Such a massive purchase of dollars benefited the system in two ways.

The RBI sold US dollars to the tune of $23.05 billion during the first five months of FY2023 – this would enable the RBI to significantly gain from transactions in two currencies.

This has also helped the RBI to mitigate the outflows of dollars due to FII selling and growing trade deficits on account of ballooning oil and other fuel import bills.

Just imagine that if RBI hadn’t bought over $130 billion from the open markets in those three years, then the current forex reserves would have been just around $410 billion!

The same would have depreciated the Indian rupee much more, impacted the import bill in the rupee term and also would have accelerated inflationary conditions more painfully.

Apart from the sale of dollars in the open markets, the steep rise in trade deficits caused by the substantial rise in oil and coal prices and also FII selling of Indian equities have brought down India’s forex reserves to the current level of $544 billion from the record high level of $642 billion in September 2021.

While the FIIs pressed huge selling of Indian equities starting from October 2021, the commencement of the Ukraine war in February 2022 led to spiralling oil and other fuel prices.

FIIs have sold (net) over $45 billion of Indian equities since October 2021. Crude oil prices moved up almost 50% from pre-Ukraine war levels.

Certainly falling reserves on account of the selling of equities by the FIIs and growing trade deficits are not good for the Indian economy nor for the equity markets as the same is the consequence of rising inflationary pressures and weakening of India’s external economic conditions.

Still, the domestic equity markets have risen from the bottom and in fact, it has outperformed many major markets in the world.

This only indicates that there is hope for rebuilding the forex reserves in the near future – while oil has fallen over 32%, metals have fallen up to 35% from their respective 52-week highs.

There is also moderation in the gold imports consequent to the rise in import duty on gold. Since the month of July 2022, the quantum of selling of Indian equities by the FIIs has also been tapered off.

Their net selling fell as low as 489 crore. In the current month of November 2022, their purchase exceeds 12,000 crore.

A steep fall in oil prices is a single solution for the multiple problems of the Indian economy viz, soaring inflation, declining forex reserves and rupee exchange rate, and consequent FII selling.

The recent crash in oil prices should enable India to moderate inflation significantly further, reduce trade deficits and thereby increase the forex reserves and rupee exchange rate.

The domestic markets seem to be smart enough to understand that the oil price has to fall eventually as the global GDP growth slowed considerably and therefore, it didn’t react adversely to the declining trend in forex reserves.

Perhaps, the dwindling forex reserves saw a bottom already - in the week ending November 11, 2022 forex reserves rose at the fastest pace in more than a year.

There are reports of huge floating storage of crude oil in the world – any further fall in oil prices would lead to this speculative storage of oil hitting the markets which in turn could lead to a further major fall in oil prices.

Hence, there is ample scope for soaring up of forex reserves as well as the domestic equity markets further upwards over the next three to six months.

A significant build-up in reserves would strengthen the rupee and the FIIs are likely to mop up substantial quantities of Indian equities over the next six months.

(The author of this article is the Founder & Head of Research of Equinomics Research & Advisory)

Disclaimer: The views and recommendations given in this article are those of the author. These do not represent the views of MintGenie.

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First Published: 22 Nov 2022, 11:34 AM IST