India’s forex kitty swells to $579 bn, insulates economy from taper tantrum

India’s forex kitty swells to $579 bn, insulates economy from taper tantrum
The increase in the country’s forex kitty is the highest ever annual accretion and is a direct result of the proactive policies and far-reaching reforms initiated by the Narendra Modi government.Courtesy: Reuters

US T-bill yields are rising and the West will have to start tapering off their stimulus packages soon. That will lead to a flight of dollars away from emerging markets to safe havens in the West. But far-reaching reforms and sound macro-economic management by the Modi govt and RBI have ensured that India will not be hit too hard.

India's foreign exchange reserves grew $101 billion during the last fiscal. The country now has the world's third largest forex reserves of $579 billion, after China ($3.2 trillion) and Japan ($1.3 trillion). This will give comfort to investors that India's economy will not be impacted too much when, inevitably, the US and European central banks begin to taper off their huge stimulus packages, forcing investors to start selling emerging market securities for safe haven papers like US Gilts.

The increase in the country’s forex kitty is the highest ever annual accretion and is a direct result of the proactive policies and far reaching reforms initiated by the Narendra Modi government. These have led to a surge in foreign investments into the country over the last year.

Inflows have come through FDI

Much of this incremental amount of foreign exchange has come in the form of foreign direct investment (FDI), which is considered more “sticky”, i.e., such investors pour in investments with a long-term horizon and invest in creating assets and jobs in the country. And unlike foreign portfolio investments, which can be withdrawn at a moment’s notice, such investments stay within the country for long periods of time.

The increase in the country’s forex kitty is the highest ever annual accretion and is the result of the proactive policies and far reaching reforms initiated by the Modi government.

FDI inflows into India in the first nine months of 2020-21 were at $67 billion, a record. Of this, Mukesh Ambani’s Reliance Industries alone has attracted FDI flows of about $25 billion in its two subsidiaries, Reliance Jio and Reliance Retail.

A broker takes a photo of the days results on the stock market. India’s foreign exchange reserves, which had touched a record high of $590.19 billion in the week ended January 29, 2021 before dipping slightly to their current levels, are now sufficient to cover one year’s worth of imports.
A broker takes a photo of the days results on the stock market. India’s foreign exchange reserves, which had touched a record high of $590.19 billion in the week ended January 29, 2021 before dipping slightly to their current levels, are now sufficient to cover one year’s worth of imports. Courtesy: ANI

Stock market investors pumped in billions

Then, foreign portfolio investors (FPIs) have also poured in another $37 billion into the Indian stock markets. This is particularly significant as the country has just emerged from a technical recession, defined as two consecutive quarters of GDP contraction, as a result of the headwinds generated by the Covid-19 outbreak.

Thus, India’s foreign exchange reserves, which had touched a record high of $590.19 billion in the week ended January 29, 2021 before dipping slightly to their current levels, are now sufficient to cover one year’s worth of imports.

The country is, thus, strongly placed to deal with the inevitable flight of capital to safer harbours when the US and European central banks begin to wind down their expansionist monetary policies.

The last “taper tantrum” in 2013 led to a near run on the rupee, which depreciated almost 30 per cent against the dollar between May and August, causing severe economic mayhem and leaving a trail of financial misery in its wake.

Much of this incremental amount of forex has come in the form of FDI… Such inflows into India in the first nine months of 2020-21 were at $67 billion, a record.

Recalling the 2013 taper tantrum

Just to recall, the US Federal Reserve Chairman Ben Bernanke’s announcement in May that year that it would wind down its massive programme of buying bonds, which was infusing humungous amounts of liquidity into the global monetary system, led to a massive sell-off in emerging market stocks. This money then flowed back to safe havens in the US and Europe causing huge depreciations of many emerging market currencies against the dollar.

India was particularly badly affected as its macro numbers and other economic fundamentals were weak. That was a period when the Indian economy was still under tremendous stress following the post-2008 expansionist policies followed by the then UPA government and the RBI. The country had massive foreign financing needs and a large and expanding current account deficit. Growth rates were slowing and inflation was on the rise.

India’s external financing needs are under control, the inflation rate is still within RBI’s comfort zone, and the country is expected to post a current account surplus of 2% in 2020-21, a first in 17 years.

Most other emerging markets also suffered similar similarly. The Indian economy teetered on the brink for a few months, earning it a dubious moniker of being a Fragile Five economy that could collapse at any moment.

This came to be dubbed the “taper tantrum”.

US T-bill yields are rising again

As US T-bill yields have risen to 1.4 per cent from 0.9 per cent at the beginning of the year, many experts are expecting a 2013 redux. This time, however, despite being buffeted by the Covid wave, the Indian economy is much better placed to absorb the shocks that will emanate from another tapering of expansionist fiscal policies in the West.

Employees work on a production line manufacturing protective suits at a factory. Reforms and the unveiling of PLI schemes in 13 sectors are expected to ensure a rising flow of foreign exchange into the country.
Employees work on a production line manufacturing protective suits at a factory. Reforms and the unveiling of PLI schemes in 13 sectors are expected to ensure a rising flow of foreign exchange into the country.Courtesy: ANI

Macro fundamentals in better shape

India’s external financing needs are well under control and within prudent limits, the inflation rate, though on a rising trajectory, is still within the RBI’s comfort zone, and, according to the Economic Survey tabled in Parliament on January 29 this year, the country is expected to post a small current account surplus of 2 per cent in 2020-21, a first in 17 years.

Then, a series of reforms and the unveiling of production-linked incentive (PLI) schemes in 13 sectors are expected to ensure a rising flow of foreign exchange into the country.

Thus, sound macro-economic management by the Modi government and RBI and the huge and rising forex kitty have almost certainly ensured that a repeat of the 2013 taper tantrum is not on the cards.

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