No amount of forex reserves is ever adequate

In April 2018, India's foreign exchange reserves had hit a life-time high of $425 billion. Things have changed since then. The forex reserves have been falling by about $2 billion a week for seven weeks and present balance is under $400 billion. But government maintain that there's no reason to panic. Falling reserves are a result of RBI's intervention to arrest the slide of the rupee, which has depreciated around 8% in this year (16% in the past 2 years). On Aug 17, 2018 USD/INR touched 70-mark and analysts predict it may touch even 80. Widening trade deficit, sluggish export growth could put further pressure on the country’s forex reserves. 

• Our CAD worsened from $15 billion in 2016-17 to $49 billion in 2017-18. Higher oil prices were only partly to blame. Exports struggled, while we guzzled smartphones and gold. Our FDI/FII flows flipped from an inflow of $21 billion in FY17 to an outflow of $19 billion in FY18.
• The Centre’s response to the rupee weakness was nonchalant. RBI was mum and FM tweets that India’s FE reserves are comfortable, going by global standards and sufficient to mitigate any undue volatility in the FE market.
• Although India's FE reserves are better than many emerging economies, we should remember that no amount of forex reserves is ever adequate and it might not be right to feel complacent about the country’s FE reserves.
• Given that the country’s widening trade deficit, sluggish export growth and growing imports — our FE reserves are likely to be under pressure in the coming quarters. It is therefore better to acknowledge the challenges and think about corrective actions, rather than be in denial.
• After the 2013 crisis, the RBI has been careful about building its forex reserves. Reserves had increased from $275 billion in Sep 2013 to the life-time high of $426 billion in April 2018. Apart from low oil prices & higher NRI remittances, strong inflows from FII's/FPI's and FDI's helped to a large extent in shoring up reserves.
• But this support is likely to be withdrawn in the coming quarters.
• FDIs had been robust in the first two years of NDA rule, growing at 25% and 23% in FY15 and FY16 as PM Modi reached out to overseas investors to fund the country’s growth. But the momentum has slowed down since then with the FDI inflows growing 8% in FY17 and at an even slower pace of 3% in FY18.
• FII's have withdrawn ₹15,771 crore from the equity market for far in FY19 while the outflows from debt segment has been ₹35,449 crore. (In FY18, there were inflows of ₹1,44,682 crore in equity and debt markets).
• In addition between April and June 2018, RBI sold off $14 billion to stave off depreciating rupee. It is therefore not surprising that the reserves are down 10% their peak level recorded in April 2018.
• The Federal Reserve began shrinking its balance sheet since Oct 2017. This is reducing liquidity in global markets, the rate hikes from the Fed are making the cost of financing expensive. It is therefore not surprising that global investors are reducing their investments in emerging markets including India.
• The IMF estimates that the Fed’s tightening can result in reducing flows into emerging markets by $35 billion a year. The world is moving from a period of easy money to one were liquidity becomes tighter and funds become more expensive.
• With Federal Reserve and Bank of England hiking interest rates, the cost of refinancing the loans will become difficult, leading to repayment of some of these loans, causing forex outgo.

There are no easy fixes to this problem. The measures taken to improve the ease of doing business and GST are likely to improve FDI flows in the long term. The government needs to renew the efforts to boost exports, reduce dependence on imports in order to ensure a sustained improvement in the country’s reserves.

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Rupee is expected to remain under pressure in the near future due to rising oil prices, global trade wars, tightening of global liquidity and a strong dollar. When USD/INR touched 70, Union Minister Arun Jaitley said that India’s foreign exchange reserves are comfortable by global standards and sufficient to mitigate any undue volatility in the foreign exchange market. He is only monitoring and reassuring but not indicating any corrective steps. By not improving our exports and reduce dependence on imports, during the past 4 years of low oil price regime, we have squandered away the opportunity to consolidate our economy. Now we can only look eastwards and pray God to help us.