MC Explains: Why India’s forex reserves fell to the lowest level in over 14 months

India’s foreign exchange reserves fell $5 billion from $593.3 billion in the week ended June 24 to $588.3 billion as of July 1, the lowest level in over 14 months, showed recent data from the Reserve Bank of India (RBI), as the central bank sold dollars to safeguard the rupee.

In its financial stability report released on June 30, the RBI said the current level of reserves is sufficient to meet nearly 10 months of imports projected for the current year.

Here are the major reasons that led to the massive fall in the forex reserves.

1. Russia-Ukraine conflict: Since the war broke out, there has been a significant outflow of funds from the domestic market. So far in July, foreign portfolio investors (FPIs have withdrawn $543.94 million from Indian financial markets, data from the National Securities Depository showed. “Whenever there is any geopolitical crisis, investors tend to rush towards the safe-haven currency like the dollar. So they dumped emerging market assets and thus there have been capital outflows from the Indian market,” said Sugandha Sachdeva, vice-president, commodities and currency research at Religare Broking.

2. Rising oil prices: Another major factor that contributed significantly to the fall in forex reserve is higher crude oil prices. This has widened the country’s trade deficit and pushed up the current account deficit numbers. “The import bill goes higher and we need to pay more money if the price of oil is rising, which means more outflow of dollars leading to higher trade deficit,” said Kunal Sodhani, assistant vice-president, Shinhan Bank, Global Trading Center, forex and rates treasury.

3. FCA accounts suffering due to growing dollar strength: A large part of forex reserves is by way of foreign currency assets (FCA) accounts, pointed out foreign exchange analysts and researchers. In FCA, the dollar, euro and pound constitute a significant part. But with the outbreak of hostilities in Eastern Europe, both the pound and euro have been sliding, which had an effect on India’s forex reserves.

Out of $588 billion, FCA was around $546 billion in 2021. “Since GBP (pound), euro were performing well too, the valuation of FCA account was high and went up higher on a month to month basis. Since the war broke out, the reserve was declining and RBI sold nearly $30 billion on a monthly basis,” said Arnob Biswas, head of forex research at SMC Global.

The RBI has had to sell massive amounts of the dollar after the war broke out to ensure that the rupee did not depreciate too much. With the euro and pound falling after the war, the FCA valuation is in turn getting lower day by day.

4.Safeguarding rupee in focus: According to analysts, the major focus of the Indian central bank has been to prop up the rupee and in doing so it ended up depleting the forex reserves to some extent. “The RBI sold dollars to protect the rupee from depreciation. They are not protecting any level but supplying dollars at every spike to ease the volatility,” said Saurabh Goenka, CEO and MD, Zenith FinCorp.