- November 25, 2020
- Posted by: Amit Pabari
- Category: Currency
The foreign exchange reserves have raised from $469.91 billion in mid-March to $572.7 billion as of today, which is nearly a 21.87 percent rise following a sharp decline in imports alongside strong foreign investment inflows in the second half of the calendar year. With this figure, India is just $11 billion far to surpass Russia and marking its position on number 4.
In our past report of August, when the rupee traded above 75.50 levels and RBI had bought over $60 billion since March, we had raised that if RBI gets slow in buying, the rupee shall strengthen significantly. After hoarding $100 billion reserves in its bucket, let’s understand the broader objective of the RBI and its probable impact on the rupee going further.
Why is RBI building Reserves? – “A border vision”
Higher debts: India’s external debt stood at $554.5 billion at end-June, recording a decrease of $3.9 billion over its level of March 2020. Commercial borrowings remained the largest component of external debt, with a share of 38.1 percent, followed by non-resident deposits 23.9 and short-term trade credit 18.2 percent. At end-June 2020, long-term debt was placed at $ 449.5 billion, recording a decrease of $ 2.0 billion over its level at end-March 2020, while the short-term debt declined to 18.9 percent from 19.1 percent at end-March 2020. Amid higher debt levels, external positioning of the country gets hampered leading to a risk of degradation of the country’s credit rating notch which is already a level above negative. A negative rating of a country’s external positioning is a risk for foreign investments in terms of FDI’s and FII’s. As the main agenda of the connect government is to attract more and more FDI’s and FII’s into the country, increased foreign reserves help to compensate for the higher debt levels in the eyes of a foreign investor.
China’s strategy: In the past few decades, China has taken its reserves to $ 3.15 trillion being the number one in the race of highest reserves in the world. China accumulated foreign reserves for decades until they reached an all-time high of US$3.99 billion in 2014, as the PBOC kept buying US dollars that Chinese exporters accumulated through foreign sales, holding down the value of the Yuan. China appears to have made a policy decision to keep the reported reserves on the PBOC’s balance sheet stable, even though China continues to manage its currency and aims to keep its Yuan broadly stable, thereby keeping a good external position of the country. India somewhere wants to adapt the path taken by China and mark its prints by aspiring to turn surplus nation by boosting exports and curbing the import dependency helping the country build higher reserves.
Managing volatility: Overall, if a country has higher reserves it helps to insulate the nation where another Sub-prime-like crisis takes place, RBI can get the dollars back which helps to support the economy. Also, it helps to curb the near-term volatility if the speculative bets on currencies rise.
Hence, it seems quite clear that RBI shall remain persistent in buying dollars.
With that, will Rupee depreciate?
Well, ideally when the central bank remains an aggressive buyer of the dollar, the rupee should depreciate. However, there are times when RBI reduces the pace of buying and might sometimes change its stance as seen in August.
Meanwhile, if the inflows remain robust as seen in the current month, it’s easy for the rupee to shift its trajectory on the stronger side until the next time when RBI begins to intervene aggressively again. For now, RBI has protected 73.80 levels but a border base is near 73.00 levels which RBI shall hold considering the support needed on the exports front. On the upside, losses arising out of any uncertain events shall be capped close to 75.00 levels as RBI might not be tolerant with rupee depreciation past that amid elevated inflation. Hence the border range for the rupee is likely to rule out within 73.00-75.00 levels for a few more months. Until then, a safe play would be selling on upticks between 74.50-74.90 and buying on dips between 73.00-73.50 levels.
-Amit Pabari is managing director of CR Forex Advisors. The views expressed are personal.