An Indian ten rupee banknote and U.S. one-hundred dollar banknotes are arranged for a photograph in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

India's Reserves Head for $400 Billion as RBI Defends Rupee

(Bloomberg) -- India’s foreign exchange reserves may soon drop below the $400 billion mark for the first time since November as the central bank steps up action to shore up one of Asia’s worst-performing currencies.

Reserves have steadily declined by $21 billion from a record peak of $426 billion in mid-April, and official data on Friday showed it was little changed in the week through July 20 at $405 billion. With the rupee set to remain under pressure in the face of an emerging-market sell-off, trade war jitters and a stronger dollar, there’s hardly any sign the central bank will ease up on its currency intervention.

The magnitude of the slump since the April peak matches the drop in reserves in the four months through August 2013 in the aftermath of the so-called taper tantrum, when the rupee plunged more than 15 percent against the dollar.

The rupee has lost about 7 percent against the dollar so far this year and closed at 68.6625 per dollar on Friday, not far from its record low.

Reserves are still strong enough to cover more than nine months of import needs, and policy makers aren’t panicking for now. To strengthen buffers, Economic Affairs Secretary Subhash Chandra Garg said last month the government isn’t averse to a foreign currency non-resident type deposit collection while keeping alive the option of a sovereign bond issue. But there’s no immediate need for these, he said.

If the rupee’s weakness is sustained, policy makers have other options available to curb the current-account deficit and limit foreign-currency demand, including import tariffs, caps on external debt and off-market swap deals with oil importers.

Here are some of the reasons reserves will remain under pressure:

Foreign Outflows

Nearly $7 billion from Indian bonds and stocks have exited so far this year and the Reserve Bank of India has sold dollars steadily to smooth the volatility. With the U.S. Federal Reserve set to hike interest rates further and trade tensions weighing on global growth, foreign investors are pulling out of emerging markets to safer havens.

Governor Urjit Patel has expressed worries about the emerging-market turmoil, arguing that the Fed’s plans to shrink its balance sheet are adding to risks.

The RBI raised interest rates for the first time in four years in June and another quarter percentage point hike is possible next week as inflation hovers above the RBI’s medium term target of 4 percent. Higher rates boosts the appeal of Indian assets and helps to retain almost $100 billion in short-term debt that the RBI considers hot money, which can quickly leave the country in times of global risk aversion.

India's Reserves Head for $400 Billion as RBI Defends Rupee

Trade Wars

India won’t be spared if trade friction between the U.S. and China hurts global growth and slows export demand. The trade shortfall is already at a five-year high, a key reason the current-account deficit is seen widening to 2.4 percent of gross domestic product in the current fiscal year ending March 2019.

India's Reserves Head for $400 Billion as RBI Defends Rupee

“India’s exports could come under pressure if these headwinds persist,” said Kapil Gupta, an analyst at Edelweiss Securities Ltd. That’s not good news for the trade balance as a larger deficit usually puts more downward pressure on the currency.

Import Bill

India is the world’s fastest growing oil user and a 50 percent jump in crude prices from a year ago have pushed up the import bill, adding to pressure on the current account, while also worsening the inflation outlook.

With the economy rebounding this year, imports of electronic goods are also up more than 20 percent from a year ago. Strong domestic consumption and a modest recovery in investment could spark demand for more capital goods imports.

India's Reserves Head for $400 Billion as RBI Defends Rupee

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