India’s Steady Climb In The Forex Reserve League-Tables Continues

India’s foreign exchange reserves continue to move from one record high to the next, as inflows through portfolio flows and external borrowings remain robust.

For the week ended Feb. 7, total forex reserves rose to $473 billion from $471.3 billion the week before.

India’s forex reserves have now risen steadily since 2013 when the Reserve Bank of India introduced a scheme to draw in foreign currency non-resident deposits amid a weakening currency.

The Top Reserve Holders

The top two reserve holders globally continue to be China and Japan, by a wide margin.

At the end of January 2020, China held $3.2 trillion in reserves. Japan held $1.3 trillion. Other countries like Switzerland ($855 billion), Russia ($562 billion) Saudi Arabia ($499.5 billion as on December 2019), Taiwan ($479 billion) follow.

India, with $473 billion, follows these countries. The data has been compiled from central bank disclosures.

Higher forex reserves will always bode well for India, which remains a current account deficit economy, said Madhavi Arora, economist at Edelweiss Securities.

That is especially important in today’s times when global vulnerabilities remain, she said.

Radhika Rao, economist at DBS Bank, agreed. Authorities have been steadfast in building reserves to provide a strong buffer against global uncertainties, Rao said. “This ensures a stable currency in the face of short-term flows and contains vulnerabilities arising from rising external debt, owing to higher external commercial borrowings last year,” Rao said.

Forex reserves have built up due to a steady trickle of capital across categories like foreign direct investments, foreign portfolio investments and external commercial borrowings. Some of these flows are seen as debt creating and hence can also add to the country’s external vulnerabilities.

Adequacy Of Forex Reserves

To be sure, judging the adequacy of forex reserves goes beyond just absolute values. The RBI uses metrics such as import cover and reserves as a percentage of short-term debt to judge whether India is well prepared for volatility.

At present, reserves are adequate by some commonly used metrics.

Import Cover

The current level of forex reserves are adequate to cover nearly 12 months of imports. This is well above the level of six-seven-month coverage that markets deem as necessary. To be sure, in recent months, the fall in imports has also led to an increase in the reserve cover. Yet, even over a 12-month period, reserves have been enough to cover 10-11 months of imports.

Reserve Cover of External Debt

The reserve cover of total external debt declined from 80.2 percent at the end of FY18, to 76 percent at the end of FY19. However, it has inched up once again. At the end of September 2019, the reserve cover rose to 77.8 percent, according to an RBI bulletin published on January 11, 2020.

Data beyond September is not yet available.

In September, the reserves provided a cover of 181.2 percent and 397.4 percent for short-term debt on residual and original maturity basis, according to the bulletin. The Greenspan-Guidotti rule, which is a widely used thumb rule for reserve adequacy, recommends at least 100 percent of reserve cover of short-term debt on residual maturity basis. India is well ahead of that.

Still Not Enough?

The RBI, however, is undertaking a review of what level of reserves is seen as adequate. The review was undertaken following the recommendations of a committee headed by former governor Bimal Jalan on the central bank’s wider economic capital framework. Forex reserves form a large part of the central bank’s balance sheet.

In its report in September 2019, the committee noted that “India’s forex reserves are significantly lower than the country’s total external liabilities ($1 trillion) and even lower than total external debt ($500 billion).” This position, according to the committee, is in contrast to that in 2008 when India’s foreign exchange reserves exceeded the then total external debt and provided a much larger cover in relation to external liabilities.

“This needs to be taken into account in assessing the external risk being faced by the country,” the committee said.