Thursday, December 9, 2021

How Has India Built Large Forex Reserves Despite Perennial Trade Deficits?

India's forex reserves of nearly $640 billion are the 4th largest in the world despite the fact that it runs trade deficits year after year.  Other nations among the top 5 with the biggest US dollar reserves are China ($3.4 trillion), Japan ($1.4 trillion) , Switzerland  ($1.1 trillion) and Russia ($623 billion). They have all accomplished this feat by running large trade surpluses for many years. 

History of India's Trade Deficits in billions of US dollars. Source: Trading Economics

So how did India manage to build over $600 billion in US dollar reserves? The top contributor to India's reserves is debt which accounts for 48%. Portfolio equity investments are known as “hot” money or speculative money flows accounted for 23% of India's forex reserves, according to an analysis published by The Hindu BusinessLine

While India has accumulated the largest forex reserves in its history, its debt to GDP ratio is also nearing an all-time record of 90%, the highest in the South Asia region. India's debt has risen by 17% of its GDP in the last two years, the most of any emerging economy. By contrast, Pakistan's debt to GDP ratio has increased by a mere 1.6% to 87.2% from 2019 to 2020.


India's Rising Debt. Source: Business Standard

The International Monetary Fund (IMF) has projected the Indian government debt, including that of the center and the states, to rise to a record 90.6% of gross domestic product (GDP) during 2021-22 against 89.6% in the previous year. By contrast,  the percentage of Pakistan's public debt to Gross Domestic Product (GDP) including debt from the International Monetary Fund, and external and domestic debt has fallen from 87.6% in Fiscal Year (FY) 2019-20 to 83.5% in FY 2020-21.    

While large reserves are a source of comfort in terms of balance of payments and currency stability, it also has significant downsides. The biggest risk is the interest rates on the debt (accounting for 48% of India's US$ reserves) which depend heavily on the US Federal Reserve's monetary policy. Should the Fed decide to raise interest rates to tighten money supply amid inflation concerns, the cost of servicing the US dollar denominated debt will rise. 

The second big worry is that the "hot money" accounting for 23% of India's US$ reserves could suddenly decide to leave India for better returns elsewhere. This happened in the Asian Financial Crisis of 1997-98. It began in Thailand and then quickly spread to neighboring economies. Initially, it was a currency crisis when Bangkok unpegged the Thai baht from the U.S. dollar that set off a series of currency devaluations and massive flights of capital. 

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4 comments:

Riaz Haq said...

Funds Shun #India Turning #India #Rupee Into EM Asia’s Worst Currency. #INR declined 1.9% this quarter as global funds pulled $4.2 billion of capital out of India’s #StockMarket, the most among regional markets where data is available. #Modi #BJP #Hindutva https://www.bloomberg.com/news/articles/2021-12-21/global-funds-shunning-india-turns-rupee-into-worst-asia-currency

Rupee may fall to 76.50 by end-March: Bloomberg survey
Rupee declines 1.9% this quarter, worst in emerging Asia


The Indian rupee is set to end a tumultuous year as Asia’s worst-performing emerging market currency with foreign funds fleeing the nation’s stocks.

The currency declined 1.9% this quarter as global funds pulled $4.2 billion of capital out of the country’s stock market, the most among regional markets where data is available.

samir sardana said...

The reason Y USD cones to India,is the gravitational law,of interest differentials.

Fx surpluses in US and EU,with States and funds,look for places,to park debt.Soverign risk is in US T-bills or USPR,so the funds start shopping for nations,with the highest soverign rating - which subsumes all risks.

So in that pecking order,India comes at 6 or 7,as it HAS SCALE.There are many other nations, with a HIGHER rating,BUT THEY ARE RICH NATIONS,who will offer close to USPR,and whose currencies will move, with large USD inflows.

INDIA NEEDS MONEY FOR INFRA ETC.
INDIA NEEDS USD DEBT FLOWS FOR MANAGING THE INR
IT HAS A LARGE DEBT MARKET
AND SO,IT CAN OFFER RATES MUCH MIGHER THAN USPR,WITH SOME CAPITAL PROTECTION AND SOME LOCK IN.

FOR US AND EU - PRC AND RUSSIA HAS POLITICAL RISK - WHICH IS NOT THERE IN INDIA - AS INDIANS ARE LAPDOGS OF THE US AND EU.HENCE,CAPITAL RISK IS ZERO !

INDIA GAINS BY USD DEBT,AS IT LENDS PACKING CREDIT,FCNR AND INFRA DEBT IN USD,TO LOWER THE COST OF CAPITAL,TO INDIAN EXPORTERS AND DEEMED EXPORTERS.

THEREFORE,THEY CAN SHARE THE GAINS,WITH THE USD DEBT HOLDERS,AND OFFER MUCH HIGHER RATES,AT THE SAME LEVEL OF SOVERIGN RISK.

ALL THE USD DEBT,IS FLOATING RATE DEBT,LINKED TO LIBOR OR USPR - AND THE COST WILL RISE, WITH US FED RATE HIKES - AND THAT IS WHEN INDIA WILL NEED MORE USD DEBT - AS COVID WILL DESTROY GROWTH,AND OIL PRICES WILL NOT FALL,AND THE WORLD IS DUE,FOR A FOOD AND FERTILISER SHOCK.dindooohindoo

IN THAT SCENARIO - WHEN INDIANS NEED MORE USD DEBT - WILL THE INVESTORS LEND - THAT IS THE QUESTION !

OR WHEN PLAF JF-35s,LAND ON THE ROADS OF THE RASHTRAPATI BHAWAN.

Riaz Haq said...

#India's #forex #reserves slide for fourth straight week amid decline in currency assets.Falling forex reserves may cause issues for #Modi government and the Reserve Bank in managing the nation’s external and internal financial issues. https://indianexpress.com/article/business/market/forex-reserves-slide-for-fourth-week-7690545/ via @IndianExpress

Recording a fall of $160 million, the nation’s forex reserves declined to $635.667 billion during the week to December 17, according to data from the RBI.

For the previous week ended December 10, the foreign exchange — or forex — reserves had fallen by $77 million to $635.828 billion. The forex kitty had reached an all-time high of $642.453 billion during the week ended September 3, 2021.

For the reporting week ended December 17, the decline was mainly due to a fall in foreign currency assets (FCAs), a vital component of the overall reserves. This is the fourth straight week of fall in the reserves.

FCAs tumbled by $645 million to $572.216 billion, weekly data released by the Reserve Bank of India (RBI) showed on Friday.

Expressed in dollar terms, the FCA include the effect of appreciation or depreciation of non-US units such as the euro, pound sterling and Japanese yen held in the foreign exchange reserves.

Gold reserves rose by $475 million to $39.183 billion in the reporting week.

The special drawing rights (SDRs) with the International Monetary Fund (IMF) remained unchanged at $19.089 billion.

The country’s reserve position with the IMF increased by $9 million to $5.179 billion in the reporting week, as per the data.

Falling forex reserves may cause issues for the government and the Reserve Bank in managing the nation’s external and internal financial issues.

Higher reserves are a big cushion in the event of any crisis on the economic front and enough to cover the import bill of the country for a year. They also strengthen the rupee against the US dollar.

An increase in reserves also provide a level of confidence to markets that a nation can meet its external obligations, demonstrate the backing of domestic currency by external assets, assist the government in meeting its forex needs and external debt obligations, and maintain a reserve for national disasters or emergencies.

The Reserve Bank functions as the custodian and manager of forex reserves, and operates within the overall policy framework agreed upon with the government. It allocates the dollars for specific purposes.

For example, under the Liberalised Remittances Scheme, individuals are allowed to remit up to $250,000 every year. The RBI uses its forex kitty for the orderly movement of the rupee. It sells the dollar when the rupee weakens and buys the dollar when the rupee strengthens. WITH PTI

Riaz Haq said...

#India’s current account deficit grows as #trade gap widens in Q3. Net foreign portfolio #investment fell to $3.9 billion from $7 billion a year ago; net #FDI inflows at $9.5 billion, down from $24.4 billion a year ago.#Modi #BJP #Hindutva #Islamophobia

https://www.bloomberg.com/news/articles/2021-12-31/india-s-current-account-slips-back-to-deficit-on-wider-trade-gap

India’s current-account balance slipped back into a deficit last quarter as the nation’s trade gap widened.

The current account, the broadest measure of the country’s overseas trade and services flows, was in a deficit of $9.6 billion, or 1.3% of gross domestic product, in the three months ended September, the Reserve Bank of India said in a statement on Friday. The median in a Bloomberg survey of 12 economists was for a deficit of $10.9 billion.

The account was in a surplus of $6.6 billion in the April to June period, and also a surplus of $15.3 billion, or 2.4% of GDP, in the comparable year-ago period.

Digging Deeper
The latest numbers come on the back of a surge in global crude oil prices which inflated India’s import bill; the RBI cited widening of trade deficit to $44.4 billion from $30.7 billion in the preceding quarter and an increase in net outgo of investment income for the current-account gap
Income from services decreased sequentially, but increased on a year-on-year basis on robust performance of computer and business services, the central bank added
Friday’s data, which covers a period when economic activity in India was picking up after a second wave of Covid-19 infections, saw private transfer receipts, mainly representing remittances by Indians employed overseas, rise 3.7% from a year ago to $21.1 billion
Net foreign portfolio investment was $3.9 billion as compared with $7 billion a year ago; net foreign direct investment inflows amounted to $9.5 billion, lower than $24.4 billion a year ago