Chart of Day: Forex reserves are no vibranium shield against Fed tightening

Representative Image (Source: ShutterStock)

If you are a Marvel Comics fan, chances are you would have got behind the indestructible vibranium metal as the ultimate shield against every attack. Similar status has been awarded to India’s forex reserves over the past two years. From market chatter to policy statements, almost all conversations about the Indian rupee’s depreciation involve the adequacy of the country’s forex reserves in limiting an otherwise debilitating impact of the US Federal Reserve’s tightening spree.

This argument is being put to test since the last few months as dollar outflows persist, depleting reserves faster than anticipated. India’s foreign exchange reserves are down $42 billion from the all-time high level touched in September 2021.

Much of the fall in reserves has come in just the past four months, an indication that the pressure has intensified ever since the Fed pivoted to a strong tightening message on inflation. The Fed’s latest hike of 75 basis points and the accompanying statement suggests that the central bank would blaze through with more tightening.

More than $26 billion has already flowed out of Indian markets due to the hawkish Fed and a continuation of the same would ensure that outflows persist. That means more depletion of reserves at a time when the crude oil price surge is inflating India’s import bill.

We are not only getting fewer dollars from abroad but we are also wanting more dollars to pay for oil. The import cover that reserves provide is poised to fall, already down to 10 months from a peak of 28 months in April 2020. Another factor is the coverage given to short-term debt. Nearly half the reserves would get depleted if the stock of external debt due in 2022 has to be paid off in one go. A year back, such repayment would have required only 43 percent of reserves.