India has run down its reserves by $62 billion this year while raising its benchmark interest rate just 90 basis points. Even with an expected 50 basis points hike by the Reserve Bank of India, this will still be well short of the 225 basis points of increases by the Fed.
Latest, India’s foreign exchange reserves declined $1.152 billion to $571.56 billion for the week ended July 22.
The rupee has dropped to a series of record lows during the period, but has managed to hold its place in the top half of the field for year-to-date performance among currencies in the region.
South Korea, which began raising rates 12 months ago but let itself fall behind the Fed this year, has seen a near $25 billion of drop in reserves. The won is down over 9% since the beginning of January and has hit levels seen last seen in 2009.
Thailand has seen $28 billion of depletion in its reserves while maintaining rates at a record low and seeing the baht drop 8% to the lowest since 2006. The Philippines, Indonesia and Malaysia have also seen a drop in their reserves this year.
Policy makers have also looked beyond both reserves and rate hikes to support their currencies. The RBI has eased rules to attract more dollar inflows from non-residents and foreigners into its debt. South Korea has asked its National Pension Service for more active hedging when investing abroad.
Factors for fall
The Ukraine-Russia war not showing signs to end and investors are now unsure about inflation in countries such as India that are dependent on commodities starting from crude oil to sunflower oil.
With US inflation at over 9 per cent, the Federal Reserve is on a rate raising spree — recently it increased rates by 75 basis points. This has led to exit of foreign funds from India and other emerging markets in quest of better yield in the US. According to a recent fund managers’ survey by BofA Securities, investors are bearish and have reduced allocations to emerging markets.
All this means, that the demand for the dollar is set to stay high and forex reserves under pressure.
If the current pace of around $6 billion weekly decline does not stop, India’s foreign reserves could drop by $100 billion in just four months.
India’s external account – both the current account and the Balance of Payments – deteriorated during the December quarter to a surge in Crude oil prices and a record pullout by foreign institutional investors.
The current account- sum of India’s exports and imports of goods and services- ended in a deficit of deficit at $ 23.0 billion (2.7 per cent of GDP) touched a nine- year high since the current account deficit (CAD) touched $31 billion in during the December quarter of 2012 according to the preliminary numbers released by the Reserve Bank of India. At the current levels and highest since the taper tantrums of 2013.
The CAD was less than half the latest levels at $ 9.9 billion or 1.3 per cent of GDP in Q2’2021-22 and is even higher than the deficit of $ 2.2 billion 0.3 per cent of GDP in the same period a year ago. “The widening of CAD in Q3’21-22 was mainly on account of higher trade deficit.
The primary macro variable set to deteriorate given the Russia-Ukraine conflict is the current account deficit, which is expected to exceed $100 billion in FY22-23, according to Barclays Capital. “The external balance, which had been a major factor of support for India for the past two years, has seen its vulnerability to higher oil prices decline over the years, but the simultaneous rise in prices of coal, natural gas, edible oils, and gold will weigh on the trade deficit,” it said.
India needs dollars to pay for its imports and the source of dollars is through foreign direct investment (FDI) and foreign portfolio investment (FPI). However, FDI has slowed down and there have been large FPI outflows.