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There has been a gradual decline in India’s Foreign Exchange Reserves — A cause of worry?

India's strength in the external sector may be shaking as imports are sure amidst capital outflows on account of tightening of policy rates by the US Fed. India's $600 billion strong forex reserves are adequate to finance 12 months' imports as of March 2022, down 30 per cent in a year from March 2021.

Foreign exchange reserves fell for the fifth consecutive week as the dollar reigned supreme on expectations of an aggressive US Federal Reserve monetary policy tightening path, even as the Reserve Bank of India shifts focus toward inflation and away from growth.

Indeed, India's FOREX reserves fell by $2.47 billion in the week that ended on April 8, taking the total to $600.004 billion, according to the central bank data.

That suggests the RBI has intervened to stem the rupee's weakness. What has not helped the reserves is the capital outflows when global energy prices have risen sharply to above $100 a barrel, a fallout of the Russia-Ukraine war.

The rise in global crude prices has pushed the country's import bill because India depends on imports for almost 85 per cent of its oil needs, and the dollar strength at the same time has hurt the country's external balances and the currency severely.

The latest dip in forex reserves marks the fifth straight fall, with a total of near $30 billion loss. That comes after FX reserves declined at the steepest weekly rate of $11.17 billion in the prior reporting week.

As on March 31, 2022, India’s foreign exchange reserves at $ 607.3 billion is equivalent to 12 months of merchandise imports in 2021-22 or 98.8 percent of outstanding external debt at end-December 2021, according to the latest RBI data. Exactly a year ago in March 2021 reserves were adequate to fund 17.4 months' imports.

Significantly, capital flows through various channels slowed or reversed during the year. Net FDI flows fell to $ 11.0 billion during October-January 2022 from $ 18.9 billion a year ago on the back of higher outward FDI flows and repatriations by FDI companies. Foreign portfolio investors, net buyers in Q2 '2021-22, turned net sellers from Q3 in view of the resurgence of COVID-19 infections, concerns over the pace of US Fed’s monetary policy normalization, correction in the equity market and geopolitical tensions. While ECB flows were flat, NRI deposits moderated.

Forex reserves have contracted by 5 per cent from the peak of $642 billion in October to $607 billion in March end. At the same time, merchandise imports reached an all-time high of $ 60.3 billion in December 2021 and remained above $ 50 billion for the seventh consecutive month in March 2022, hence causing import cover of reserves to shrink.

But economists are not alarmed and are convinced about RBI's ability to manage the reserves. Even at the current levels import cover is still higher than during the global financial crisis when it had slipped to less than 10 months' imports. "The RBI has been managing its foreign reserves prudently," said Rahul Bajoria, chief India economist at Barclays Capital. " As economic activity normalizes, while visually it appears that import cover is falling, we still see it being quite high and comfortable.”

While the situation is not ideal as forex reserves will be needed to cover the increasing cost of fuel and commodity imports, it is not something to be extremely worried about and make any panic decisions and investment moves.

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