ExplainedRupee
Forex reserves explained: how the RBI is spending dollars to hold up the rupee
India's reserves have fallen for six weeks in a row, to $721 billion, about $65 billion below their September record. What the reserves are, why they are shrinking, and how long the Reserve Bank can keep defending the currency.
The short answer
Foreign exchange reserves are the foreign currencies, gold and IMF claims the Reserve Bank of India holds to pay for imports and steady the rupee. They have fallen every week since a record $785.7 billion on 4 September, to $721 billion on 16 October, largely because the RBI has been selling dollars to stop the rupee falling further as oil stays above $110 a barrel. Reserves remain higher than a year ago, but the defence has a cost, and its success depends on oil, foreign investors and US interest rates.
What are forex reserves?
They are the stock of foreign money and gold that the Reserve Bank of India holds on the country’s behalf.
India’s reserves have four parts. The biggest by far is foreign currency assets: dollars, euros, yen and other currencies, held mostly as deposits and government bonds abroad. Then come gold, special drawing rights (a reserve asset issued by the International Monetary Fund) and India’s reserve position with the IMF, which is money it can draw on there.
The reserves exist for two jobs. They are a cushion that lets the country pay for imports and repay foreign debt even if money stops flowing in. And they are the RBI’s ammunition when it wants to steady the rupee.
How far have they fallen?
By about $65 billion in six weeks. Reserves reached a record $785.706 billion in the week ended 4 September. They have fallen every week since, to $721.016 billion in the week ended 16 October, the latest figure, released on Friday 23 October. That last week alone took $5.011 billion off the total, after a fall of $8.578 billion the week before.
What India's reserves are made of
Why did they hit a record in September?
Partly because of a one-off inflow from Indians abroad. A special swap window for foreign currency deposits held by non-resident Indians, known as FCNR(B) deposits, brought banks nearly $133 billion around that time, and market experts link part of the later fall to the use of those resources. Money that arrives through a swap has to be returned, so some of the fall since then is that money being used or unwound rather than reserves being “lost”.
How does selling dollars help the rupee?
It meets demand for dollars that would otherwise push the rupee down.
The rupee’s price is set in the market by how many people want to buy and sell dollars. When oil importers, foreign investors leaving Indian shares and others all want dollars at once, the rupee weakens. The RBI can step in and sell dollars from its reserves, adding supply and slowing the fall. It also uses swaps, in which it sells dollars now and agrees to buy them back later, which spreads the pressure over time.
That defence has been heavy this year. Kaveri More of Choice Broking said this month that the RBI had reportedly deployed about $75 to 80 billion through spot dollar sales and swaps since its special measures took effect on 8 June.
What else has the RBI done?
It has tried to cut demand for dollars in the first place.
On 10 October it announced steps aimed at speculative bets against the rupee. It restricted access to certain rupee contracts traded offshore to genuine hedging, extended a 20% reserve requirement to banks’ own currency hedges, and opened a special dollar window for oil companies, among the biggest buyers of dollars. The rupee, which had hit a record closing low of 96.88 to the dollar on 8 October, rose for six straight sessions after that. It closed at 94.93 on Friday 23 October as Brent crude climbed past $114.
Is $721 billion still enough?
It is still a large cushion, though shrinking. Even after the recent fall, reserves in the week to 9 October were about $35 billion higher than at the end of March and $28 billion higher than a year earlier. Not every dollar of the decline is spending, either: foreign currency assets are held in several currencies, so their value in dollars moves with exchange rates.
The risk is in the direction of travel. Each week of selling leaves less in reserve for a bigger shock, and markets watch the weekly number closely as a sign of how hard the RBI is fighting.
What decides whether the defence works?
Mostly things outside India’s control. Analysts at the Singapore bank OCBC said the RBI’s October steps “may help establish a firmer near-term footing for INR, rather than mark a decisive reversal”, because they move dollar demand out of the spot market without reducing the country’s underlying need for dollars.
That need depends above all on the price of oil, which India mostly imports, and on whether foreign investors keep pulling money out of Indian shares. US interest rates matter too, since higher returns in America draw money away from markets like India. The next reserves figure, for the week ended 23 October, is due on 30 October.