India's Foreign Exchange Reserves Will Decrease Further

As the Reserve Bank of India continues to defend the rupee against the stronger dollar, a Reuters poll predicts that by the end of 2022, India's shrinking foreign exchange reserves will have fallen to their lowest point in more than two years.

In an effort to halt the rupee's slide to a historic low against the dollar, the RBI has decreased its foreign exchange reserves by roughly $100 billion, to $545 billion from a peak of $642 billion a year ago, and more is on the way.

By the end of this year, those reserves are anticipated to fall by another $23 billion to $523 billion, according to the median forecast from a Reuters poll of 16 economists conducted on September 26-27. If achieved, that would be the lowest level in more than two years.

From $500 to 540 billion was predicted.

This suggests that the RBI would keep depleting its foreign exchange reserves at a rate unseen since the global financial crisis of 2008, when they decreased by around 20%.

The US Federal Reserve has already depleted reserves at a noticeably quicker rate than it did during the taper-tantrum phase in 2013, when it dramatically cut its purchases of government bonds.

India is in a similar situation ten years later. In spite of continued dollar sales and forecasts for more, the rupee's value versus the dollar has fallen by about 10% so far this year, and on Wednesday it hit a record low of 81.95 per dollar.

"With the last gain we have seen in the rupee, I expect the RBI to continue intervening to perhaps not try and keep a particular level of the currency, but surely try to lessen volatility," says Sakshi Gupta, chief economist at HDFC Bank.

We "would observe even more interventions in the days to come, leading in a bigger drain in the FX reserves by the end of this year" as the pressure on the rupee and the current account deficit intensify.

A tiny percentage of the economists surveyed expressed concern that the growing current account deficit, which was forecast to reach its widest point in a decade by the end of the fiscal year, might lead overall forex reserves to fall more than they had anticipated in the upcoming year.

One of the variables for the drawdown is that the RBI did not increase interest rates as swiftly as the US Federal Reserve.

A separate Reuters poll indicates that the Fed will likely increase rates by an additional 150 basis points over the coming several months, from near zero in March to 3.00–3.25%.

The RBI appears to be almost done hiking rates, even though they only started doing so in May and have only raised the repo rate by 140 basis points. Just 60 basis points are expected to be added to this cycle, with 50 arriving this week.

"The RBI should lower the degree of intervention sooner rather than later to allow INR to trade more in accordance with fundamentals," says Anubhuti Sahay, senior economist at Standard Chartered.

This remark indicates that our foreign exchange reserves should be adequate not only for the next six months but also for the following two to three years.