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Explained: Why has the forex kitty dipped $44.73 billion in 8 months?

Were capital outflows by foreign portfolio investors to blame? If the rupee slides further, will the RBI be forced to intervene?

Written by George Mathew , Edited by Explained Desk | Mumbai |
Updated: May 8, 2022 8:55:14 am
Foreign exchange reserves declined by $ 2.69 billion to $ 597.72 billion during the week ended April 29.

Eight months after hitting a record high of $642.45 billion in September 2021, India’s foreign exchange reserves have now fallen below the $600 billion mark amid capital outflows and strengthening dollar.

What happened?

Foreign exchange reserves declined by $ 2.69 billion to $ 597.72 billion during the week ended April 29. With this fall, forex reserves have declined $ 44.73 billion from $ 642.45 billion recorded on September 3, 2021, according to Reserve Bank of India (RBI) data. The decline was on account of a fall in foreign currency assets (FCAs), a major component of the overall reserves. The foreign currency assets also include the effect of appreciation or depreciation of non-US units like the euro, pound and yen held in the reserves.

Why did foreign exchange reserves decline?

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A major reason for the decline in forex reserves is capital outflows by foreign portfolio investors (FPIs) who pulled out $ 21.43 billion since September 2021 as the US Federal Reserve started monetary policy tightening and interest rate hikes. The biggest fall was in March when FPIs pulled out $ 6.56 billion. The demand for dollars also remained high as the Russia-Ukraine war led to a spike in oil and commodity prices, apart from depreciation of other currencies. The valuation loss, reflecting the appreciation of the US dollar against major currencies, and decline in gold prices have also played a part in the decline in foreign exchange reserves. Movements in the FCA occur mainly on account of purchase and sale of foreign exchange by the RBI, income arising out of the deployment of the foreign exchange reserves, external aid receipts of the Central Government and changes on account of revaluation of the assets.

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Where is the forex kept outside?

The FCAs comprise multi-currency assets that are held in multi-asset portfolios as per the existing norms, which conform to the best international practices followed in this regard, the RBI says. As of September 2021, $ 383.74 billion was invested in foreign securities, $ 147.86 billion was deposited with other central banks and the BIS and the balance $ 42.00 billion comprised deposits with commercial banks overseas. RBI’s gold holdings were 743.84 tonnes. The value of gold holdings has gone up nearly $ 4 billion to $ 41.60 billion as on April 29, 2022.

What is the impact on the rupee?

On Friday, the rupee slumped 57 paise touched a low of 76.96 – just below the all-time low of 76.97 — to close at 76.92 against the US dollar weighed down by a strong American currency overseas and firm crude oil prices. If the rupee slides further, the RBI will be forced to intervene in the forex market by selling dollars from its forex kitty, putting pressure on the total forex reserves. However, a senior RBI official has already indicated that it does not want the forex reserves to fall below the $ 600 billion level. If the RBI gives preference to sustain the forex reserves level, there could be some rupee depreciation in the horizon, analysts said.

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