The curious case of India’s rising foreign exchange reserves

With an all-time high of $611 billion in its kitty, India has galloped through Russia and South Korea as the fourth-biggest holder of Forex reserves. That’s a whopping 10,000% increase since the last 30 years!

Think of these reserves — a blend of major foreign currencies like US Dollar, Euro, and other valuable assets including gold — as the health meter of the country.

The purpose of building these up was to avoid any looming crisis, like the one in 1991. Thanks to economic liberalization, that helped in zapping out these pressures by inviting foreign investments and opening up the economy.

However, the pressing question now is: How did the Forex reserves rise so much despite the nation’s deteriorating economy?

Let’s recap the most significant events in the recent past that led to this.

The year was 2020 and the reserve balance stood at a decent $460 billion.

Due to the pandemic, a nation-wide lockdown was announced that dragged the entire economy to a standstill. People were confined to their homes and businesses were forced to shut shop. Being a country that imports a lot of oil usually, we didn’t need it in abundance anymore. This disrupted the demand for fuel drastically and on the contrary, the global price of crude oil plummeted to an unimaginable (negative) figure.

Moreover, activities such as business pursuits abroad, personal travel across countries, foreign education declined during the year.

All this significantly reduced our import bill and encouraged the RBI — guardian of the country’s economic stability — to save and accumulate these reserves.

Less expenditure on imports, more saved dollars in the kitty. Simple economics.

Another strong reason was the influx of investments from across borders. Several foreign investors were optimistic about the nation’s recovery. They, in turn, injected a lot of money in the markets with the expectation of higher returns. The hottest favourite in town — Reliance Jio helped pour in more than $20 Billion in this year alone from cash behemoths like Facebook. This raked in more valuable dollars and deepened the Forex pockets.

But, things are different in the present. As per the RBI, we have our soaring Forex reserves to stave off any immediate economic attack.

Data suggests that India surged ahead because Russia’s reserves took a beating and fell more sharply. Additionally, India’s holdings grew at a steady pace because of strong global sentiments, positive rebound in the Indian economy and unanticipated sturdy quarterly earnings.

The reasons behind this were declining COVID cases, relaxation in lockdowns and ongoing vaccination drives. Another factor that aided these inflows was staunch government support and dovish monetary policy.

However, one scenario stands tall that could inverse the flows of funds. The Fed’s stance on spiking interest rates could make India less lucrative than the US. This would hurt liquidity considerably and threaten economic recovery. To avoid a traumatic episode like the ‘Taper Tantrum’, it becomes even more integral for RBI to pump up the buffer for these reserves.

An emerging economy, like India, benefits from rising Forex reserves as it gives confidence to the people, especially in the throes of a crisis. And now you know what it takes to build this enormous pile of precious reserves.