Inflows could add to rupee appreciation pressure.

India’s foreign reserves touched a record US$393 billion early August, backed by strong foreign portfolio and investments flows while adding pressure to rupee appreciation, according to the Development Bank of Singapore (DBS).

Inferring from the central bank’s (Reserve Bank of India) intervention trends, reserves are set to rise further in the months ahead, said DBS in its daily market report on 22 August 2017.

As for the current scenario, DBS noted “strong year-to-date foreign portfolio (US$24 billion), net investment flows (US$13 billion) and lower absorption due to a narrower current account deficit have led to an increase in dollar liquidity.”

Notably, since late 2013’s taper tantrums, the quantum of jump in India’s reserves (~US$100 billion) is the highest compared to its Asian counterparts, outside of Japan.

“If left unsterilized, these inflows will add to the rupee appreciation pressures, with the Indian rupee already up 6% so far this year (against the US dollar), leading its BRIC (Brazil, Russia, India, China) peers.

“Soaking up these dollar flows have added to the surplus rupee liquidity in the system, albeit the latter at current levels is less of a worry to the central bank’s inflation mandate in midst of lacklustre credit growth,” observed DBS.

The authorities have been active not only on the spot but also in the forwards, to minimise any immediate impact on liquidity, DBS observed.

Accordingly, spot FX (Foreign Exchange) purchases amounted to US$13 billion in January-June 2017, while the net forwards position stood at US$16 billion, bulk of the latter in the three-month to one-year bucket.

Rising reserves build a buffer against external volatility, backed also by a narrower current account deficit, lowering India’s vulnerability to external risk events, believes the bank.

“However, a downside of this build-up is the associated costs and weak returns in midst of soft global yields.

“This was one of the reasons behind a reduction in the RBI’s (Reserve Bank of India) surplus dividends’ contribution to the government’s coffers, besides the cost burden associated with demonetisation and liquidity absorption,” said the DBS. fii-news.com