India’s Reserve Assets plummet by $70 billion by the end of 2022

Following a three-year period of continuous rise in forex reserves, it was noted that between the tussle of increasing interest rates and inflation, India’s foreign exchange (forex) tumbled down from $632.74 billion (in January 2022) to $562.58 billion (in December 2022). This occurred despite the Reserve Bank of India's (RBI’s) stringent reserve management measures in protecting the rupee and safeguarding capital outflows.

The Importance of Leveraging Forex Reserves

Each nation be it from developed, developing, or underdeveloped category nations must have sufficient forex reserves to safeguard them from balance-of-payment deficits, stabilize economic and financial integrity against fluctuations in exchange rates and irregular market conditions paving the way for improved policy autonomy. Foreign exchange reserves are kept as a multi-currency portfolio that includes popular currencies like the US dollar, Euro, British pound, and Japanese yen, among others, but are evaluated in terms of US dollars.

In 2022 alone, the IMF reported that foreign currency assets (FCA’s) that constitute a major chunk of overall assets fell by $71.2 billion while gold reserves recorded an increase of $461 million. This begs the question as to what led to the rise of forex reserves from 2019-2021. India recorded $61.38 billion (in 2019), $119.68 billion (in 2020), and $48.29 billion (in 2021) respectively. A part of this is attributed to exhausted US dollars, diminishing costs of crude oil, and sturdy flow of foreign investments. This was the time in which FPIs invested in the domestic equities market Rs 1.01 lakh crore (2019), Rs 1.7 lakh crore (2020), and Rs 25,752 crore (2021).

The RBI in a report by late December 2022 stated that the import cover is now affected due to the depleting reserves that caused a shortage in estimated months required for covering the imports left at 9.2 months of imports under a $564.1 billion reserve projected for 2022-23. Since around January 7, 2022, the reserves of foreign exchange covered 13 months' worth of anticipated imports for 2021–2022. At a record-breaking peak of $642.5 billion in September 2021, the reserves were enough to cover imports for 15 months.

The ‘Chief Factors’ that caused the tremendous fall of forex reserves.

Market players blame the drop in FX reserves on two factors.

(a) Valuation Loss

This took place as the US dollar steadily appreciated against all major currencies in 2022. Risk aversion tactics adopted by investors under a combative monetary consolidation of the U.S. Federal Reserve clubbed parallelly with the uncertainty clouding the Russia-Ukraine war. When the dollar appreciates, the value of foreign currencies relative to the US currency falls, which causes a nominal decline in the position of global reserves. The 10-year benchmark securities of the US and UK are two examples of dollar-denominated assets in which the RBI retains its foreign exchange reserves. India's foreign exchange reserves were influenced in 2022 because the yields on these assets increased.

(b) Heavy offloading of fly-by-night money

A wide selling spree began in the spot market when the RBI was forced to sell dollars to cope with the rapid fluctuations in Rupee’s value when large numbers of foreign investors pulled out their money. Foreign investors withdrew Rs 1.2 lakh crore from the Indian equity market in 2022. Foreign Institutional Investors (FII) sell their rupee equities investments, convert them to dollars, and withdraw the proceeds. Because there was a shortage of dollars last year, the RBI used its forex reserves to meet FIIs' dollar demand.

FPIs began leaving in 2022 due to rising interest rates combined with a jump in inflation. The Russian invasion of Ukraine amplified the FPI withdrawals also making inflows more difficult. In 2022, the rupee had vanquished higher among Asian currencies due to increased FII outflows, causing a decline of almost 10%. The RBI continued to be a net seller of US dollars between January and October 2022, as per its latest reported published findings. In the spot market, it exchanged $199.02 billion and acquired $144.58 billion. The RBI liquidated $54.44 billion in spot market transactions, on a net basis