Strong dollar inflows, including higher deposits from overseas Indians, have boosted reserves and given the RBI more room to support the rupee.
New Delhi: India’s foreign exchange reserves climbed to a record $729.3 billion in the week ended August 21, giving the Reserve Bank of India (RBI) greater room to manage pressure on the rupee amid elevated crude oil prices and global economic uncertainty.
According to data released by the RBI on Friday, India’s forex reserves increased by $12.4 billion during the week, surpassing the previous record of $728.5 billion set in February.
What is driving the rise in India’s forex reserves?
The latest increase has been supported by strong foreign currency inflows following measures introduced by the RBI in June to attract overseas capital.
One of the key measures was a special deposit programme aimed at overseas Indians and other non-resident customers.
The programme attracted around $72.8 billion in inflows through August 21, strengthening India’s external position and reducing the risk of a third consecutive year of a deficit in the country’s broadest measure of capital flows.
The stronger reserve position also gives the RBI additional capacity to intervene in the foreign exchange market if volatility in the rupee increases.
RBI gets more room to support the rupee
The Indian rupee has recovered around 1.7% from its record low in May, but remains vulnerable to external pressures.
One of the biggest concerns is crude oil. India depends heavily on imported fuel, meaning higher global oil prices can increase demand for dollars and put additional pressure on the rupee.
Higher forex reserves provide the RBI with a larger buffer to manage such pressure by selling dollars in the currency market when necessary.
However, the record reserves also come with a cost.
Overseas deposits carry a higher cost.
Under the special diaspora deposit programme, the RBI is covering the hedging costs incurred by banks. This allows lenders to offer more attractive interest rates to overseas customers and encourage them to bring foreign currency into India.
The strategy has become more expensive because US interest rates remain considerably higher than they were in 2013, when the RBI last used a similar approach to strengthen foreign exchange reserves.
Analysts have noted that the RBI generally invests the dollars raised through such programmes in relatively low-yielding assets.
If the cost of attracting the deposits is higher than the return earned on the reserves, the difference creates a carry cost for the central bank and, ultimately, the economy.
The annual cost of the arrangement could be around $5.7 billion, according to estimates cited in the analysis.
RBI closes deposit programme earlier than expected
The strong response to the scheme also prompted the RBI to bring forward the closure of the special diaspora deposit programme earlier this month.
Governor Sanjay Malhotra said the decision reflected inflows that had been stronger than initially anticipated.
For India, the record $729.3 billion forex reserve therefore represents both a stronger external buffer and the result of an expensive strategy to attract foreign currency.
The immediate advantage is clear. The RBI now has more ammunition to manage rupee volatility and absorb external shocks. The longer-term question is how much it costs to maintain that additional cushion.
Source: Gulf News
