India’s foreign exchange reserves fell by about $70 billion in 2022, following three years of increases, as inflation and interest rates increased. The reserves decreased from $632.74 billion as of January 7, 2022, to $562.851 billion as of December 30, 2022, despite the Reserve Bank of India using its arsenal of foreign exchange to stabilise the rupee and absorb capital outflows.
There are two causes given by market participants for this drop in foreign exchange reserves. One of the main causes, following the US dollar’s appreciation against major currencies in 2022, was valuation loss. Due to risk aversion among investors, the aggressive monetary tightening of the US Federal Reserve, and the uncertainty surrounding the Russia-Ukraine war last year, the US currency increased.
Anindya Banerjee, vice president (currency derivatives & interest rate derivatives) Kotak Securities Ltd., stated that “close to 55-60% of the decline (in reserves) was because of the valuation impact.”
Although they are valued in US dollars, foreign exchange reserves are kept as a multi-currency portfolio that includes popular currencies like the US dollar, Euro, Pound Sterling, and Japanese Yen, among others. According to analysts, when the dollar strengthens, the value of other currencies relative to the US currency decreases, which results in a nominal decline in the position of global reserves.
The 10-year benchmark securities of the US and UK are two examples of the dollar-denominated assets in which the RBI keeps its foreign exchange reserves. They claimed that since the yields on these assets increased in 2022, it had an effect on India’s foreign exchange reserves.
As the Reserve Bank sold dollars on the spot market to smooth out the sudden fluctuations in the movement of the rupee brought on by outflows from foreign investors, the forex reserves also decreased in addition to suffering a loss in valuation. Foreign investors withdrew 1.2 lakh crore rupees from the domestic equity market in 2022. FIIs convert their rupee equity investment into dollars, sell it, and withdraw the proceeds. Last year, there was a shortage of dollars available, so the RBI used its foreign exchange reserves to make up the difference.
FPIs began leaving in 2022 as a result of rising interest rates and a spike in inflation. According to analysts, the Russian invasion of Ukraine accentuated the FPI withdrawals while making inflows more difficult.
The rupee fell by over 10% as a result of increased FII outflows, becoming the worst-performing Asian currency in 2022. The RBI continued to be a net seller of US dollars between January and October 2022, according to the most recent data. In the spot market, it spent $199.02 billion and spent $144.58 billion. The RBI sold $54.44 billion in spot market transactions on a net basis.
The number of months of imports that can be covered by the nation’s reserves has also decreased as reserves are depleted in 2022. The Reserve Bank stated in a report from last month that the nation’s foreign exchange reserves, which stood at $ 564.1 billion as of December 9, 2022, covered 9.2 months of anticipated imports for the years 2022–2033.
As of January 7, 2022, the foreign exchange reserves covered 13 months’ worth of anticipated imports for 2021–2022. At their all-time high of $642.5 billion in September 2021, the reserves were enough to cover imports for 15 months.