India’s foreign exchange (forex) reserves have grown from $42.69 billion in the week ended April 6, 2001, to $476.09 billion in the week ended February 14, 2020—an increase of 11.15 times in absolute terms.

And, if Indranil Sen Gupta and Aastha Gudwani, both India economists at BofA Securities are to be believed, then the forex reserves kitty could swell to as high as $550 billion by the end of FY21. “We continue to expect the RBI (Reserve Bank of India) to recoup forex reserves, even at the cost of a weak Indian rupee, at every opportunity,” the duo wrote in a February 24 note. “After all, high forex reserves are India's only insurance against global contagion,” the duo added.

The duo further quoted RBI governor Shaktikanta Das’ recent (February 19) media interview in The India Express, where Das said; “So as long as the currency is stable, then people can assess and estimate the value and can take better quality decisions.” Das was pointedly asked that India has added almost $65-70 billion to its forex reserves in the past year or so, and certainly, there is a cost to it.

In his response, Das had highlighted that the underlying theme of RBI’s forex management is to see there is no undue volatility in the value of the rupee. “Because undue volatility would affect exports and imports and make life difficult even for manufacturers,” Das said. “Our effort is always to prevent any undue volatility and that stance has remained,” Das further told The Indian Express.

In their report, the BofA Securities’ economist duo highlighted that during FY20 the RBI bought $49 billion, more than offsetting the $15.4-billion it sold in FY19.

“This is aided by a falling current account deficit (revised down to 0.9% of gross domestic product from 1% earlier) on falling import demand,” Sen Gupta and Gudwani wrote.

So, what would satisfy a conservative central banker? $550 billion, in the duo’s view, still higher than the $476 billion, at an average of three metrics. One, 10-month 1-year forward import cover at imports of 20% of GDP yields $535 billion. Two, 100% cover for foreign portfolio investments (FPI), on a mark to market basis (MTM) basis, yields $520 billion. And, third, the forex reserves divided by short-term debt of 1-year residual maturity plus FPIs’ debt investments at two times works out to $594 billion.

On the import cover, the economist duo highlighted that the 1-year forward import cover has slipped to 11.1 months from 14.4 in the last upcycle. “The reason it looks relatively high is that low growth has pulled imports to 16.4% of GDP from the average 21.9% since FY06,” the duo wrote. They place ‘conservative’ forex reserves at $535 billion, at 10-month 1-year forward import cover at imports of 20% of GDP. “Empirical evidence suggests the Indian rupee depreciates if it falls below eight months.”

In support of the FPI to forex cover, pegged at $521 billion, Sen Gupta and Gudwani mentioned that FPI investments, on MTM basis, rose to 113% of forex reserves in September 2019 from 82% in 2007. “100% forex cover currently requires $521 billion of forex reserves,” the duo added.

And, on the forex reserves divided by India’s short-term debt of 1-year residual maturity plus FPI debt investments, the duo pointed out that the ratio slipped to 1.5 times in September 2019 from 3.8 times in 2007. At two times (twice the Greenspan-Guidotti rule), the RBI needs $594 billion of forex reserves.

“On balance, our BoP (balance of payments) estimates suggest that the RBI would buy $21 billion of forex in FY21,” the duo wrote. “It (the RBI) will likely shift to forward purchases to step up OMO (open market operations) to fund the Center’s FY21 fiscal deficit of 3.5% of GDP (with 30 basis points’ upside risk),” Sen Gupta and Gudwani highlighted.

Clearly, these pointers indicate that the further increasing of India’s forex reserves is the need of the hour and much more than newer records to celebrate and cheer.

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