World’s fifth-largest foreign exchange reserves provide India with cushion against economic shock

India’s forex reserves rose by $8.2 billion in the week of June 5, crossing the $500 billion milestone for the first time in the country’s history. The level of reserves is enough to cover 13 months of imports.

The growth came on the back of a rare current-account surplus in the first quarter, a return of inflows into the local stock market, and foreign direct investment, according to analysts at Standard Chartered in Mumbai. 

The vast holdings are a cushion against market volatility, showing foreign investors and credit rating companies that the government can meet its debt obligations despite a deteriorating fiscal outlook and the economy’s first likely contraction in more than four decades.

The level of reserves is equivalent to nearly a fifth of the country’s gross domestic product. It’s also the fifth-largest in the world after China, Japan, Switzerland and Russia, according to the International Monetary Fund. 

“FX reserves are more than sufficient on the adequacy metrics,” chief India economist at Citigroup in Mumbai Samiran Chakraborty told the Economic Times, noting that the last five-year average was 11 months’ cover. “Short-term debt would be around 20 percent of FX reserves, and even volatile capital flows have likely dropped to below 80 percent of reserves,” he said.

India’s trade gap narrowed to a 13-year low in May, as imports declined faster than exports. 

“Improvement in economic activity over next few quarters is likely to push the current account back into deficit,” said chief India economist at Standard Chartered’s Anubhuti Sahay. “Lower commodity prices and weak global demand are likely to negatively affect remittances inflows and services exports, weighing further on the current account balance.”

After outflows in March amid a global market sell-off, foreign investment in Indian stocks have picked up in the past two months as risk appetite returned. In addition, inflows have increased with the sale of stakes in blue-chip companies like Reliance and Kotak Mahindra Bank. “We expect similar trend in FY21 as well, with net FDI flows likely to account for nearly 65 percent of total capital inflows,” said Kaushik Das, chief India economist at Deutsche Bank in Mumbai. 

According to data from the central bank, the nation’s external debt rose to $558.5 billion as of March 2020 from $474.4 billion five years ago. The ratio of foreign exchange reserves to overall debt has also risen to 85.5 percent from 72 percent in 2015.

The level of debt that foreigners are likely to hold (including sovereign bonds) is expected to go up as India works to open its debt market to non-residents. The country is aiming for a seven percent weighting in indexes tracked by global investors, with an inclusion likely to attract billions of dollars.

“The government intends to open up more to foreign capital in the next few years as a source of deficit financing, but foreign investors’ tolerance for government debt at current levels, with a significantly larger portion of external debt, remains to be tested,” Fitch Ratings said in its recent report.

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