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Data | The strengthening of the dollar reduces foreign exchange reserves in all countries – Mintpaisa

While the rupee’s fall has been relatively subdued, the rate at which India’s foreign exchange reserves are shrinking is concerning

While the rupee’s fall has been relatively subdued, the rate at which India’s foreign exchange reserves are shrinking is concerning

The weakening of the rupee’s exchange rate and the rate at which India’s foreign exchange reserves are shrinking are again in focus. The Ukraine crisis and aggressive monetary tightening by the US Federal Reserve led the rupiah to depreciate above the 82 per dollar mark, while India’s reserves fell to a two-year low.

Reserves include foreign currency holdings, gold, special drawing rights with the International Monetary Fund and position in the reserve tranche. These external assets, controlled by the monetary authority, serve to absorb shocks in times of crisis; provide the market with assurance that external obligations can be met; and build capacity to intervene in foreign exchange markets.

Foreign exchange reserves are a crucial indicator of a country’s economic health and import capacity. Dwindling foreign exchange reserves have led to dollar shortages in many import-dependent economies, according to a Bloomberg report. As a result, countries that rely on overseas food purchases struggle to pay for commodities such as rice and wheat.

Sharp interest rate hikes from the Fed made the dollar more attractive. As a result, the dollar index has climbed 15% this year – a two-decade high – while other currencies have fallen.

Hard currencies such as the pound (-21.62%) and the euro (-17%) also weakened against the dollar. The Japanese yen, considered a safe haven, slipped to a 24-year low. Several currencies, such as the rupee, hit all-time lows, but the rupee’s fall was relatively more moderate. Chart 1 shows the evolution of the value of a currency against the dollar in 2022 (data up to October 7).

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Central banks around the world have stepped in to defend their currencies. As a result, reserves have been depleted by more than $100 billion each in China, Japan, Switzerland and Singapore. While Singapore’s reserves fell the most in percentage terms, China’s fell the most in absolute terms. As the yen broke through 145 to the dollar, Japan’s reserves fell $54 billion in the past month. Table 2 lists the decline in reserves in absolute terms and the percentage change in 2022. It also lists the total available reserves.

Over the past nine months, India’s stock of reserves has fallen by $97 billion. This is significantly higher than the drawdown on reserves during the 2008 global financial crisis ($37.3 billion) and the taper tantrum period in 2013 ($16.6 billion). A crucial difference between this crisis and the other two has been the size of India’s reserves. While India has the fifth highest reserves in the world, the rate at which they are being depleted is concerning. Reserves in September 2022 were equivalent to nine months of import cover compared to more than 15 months in September 2021. Chart 3 shows the monthly level of India’s foreign exchange reserves in 2008, 2013 and 2022.

India’s reserves are largely a product of capital flows (funds from foreign investment, borrowing) and not so much of the current account (net income earned through exports of goods and services and remittances) , which is currently in deficit. As foreign investment declined, India’s accumulation of foreign exchange reserves also declined.

With the strengthening of the dollar, the value of the euro, the pound and the yen (which are also part of India’s foreign exchange reserves) took a hit. It also led to a reduction in India’s reserves. This is called a capital loss. Chart 4 shows the evolution of India’s foreign exchange reserves due to two factors – through the balance of payments (sum of capital flows and India’s current account deficit) and through the loss/gain of Evaluation.

Source: IMF, RBI

Read also: Data | Why the Rupee is Under Pressure – Explained in Seven Charts


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