FOREX NEWS

How India accumulated forex reserves of over $600 billion – Moneycontrol.com


The balance of payment statement for 2020-21 published by the Reserve Bank of India (RBI) shows that foreign portfolio investors (FPIs) net bought equities worth $38.83 billion

India’s foreign exchange reserves topped $600 billion a few weeks ago, making the country the fourth-largest holder of the US dollar, other foreign currencies, monetary gold and special drawing rights, narrowly ahead of Russia. Only China, Japan and Switzerland currently hold more forex reserves than India. Nearly 60 percent of these reserves were accumulated after the financial and economic crisis of 2008-09. At that point, India’s reserves were worth about $250 billion.

The accretion to the forex reserves in 2019-20 was the highest since the crisis, boosted by increased net buying of Indian equities by foreign portfolio investors. The balance of payment statement for 2020-21 published by the Reserve Bank of India (RBI) shows that foreign portfolio investors (FPIs) net bought equities worth $38.83 billion, which aided an $87.3 billion jump in foreign exchange reserves. But portfolio investment alone is not the reason for the rising pile of foreign exchange reserves.

In the normal course, trade in goods and services, remittances from non-residents to resident households, repatriated incomes on investments, foreign direct investments and portfolio investment together contribute to the accretion of foreign exchange reserves of a nation.

In the instance of India, remittances from overseas workers and incomes from providing IT services have been stable sources of foreign exchange while FDI and portfolio investment inflows have been relatively volatile. Inbound tourists have been another source of foreign exchange. On the other hand, merchandise trade has usually led to a drawdown of foreign exchange reserves, as imports outstrip exports.

Here is a look at how components of the Balance of Payments contributed to the rise of forex reserves.

Portfolio investments

Between 2009-10 and 2020-21, portfolio investors net bought securities – both equity and debt – worth $221.41 billion. However, a bulk of the money was invested in equity shares, which also helped drive up the valuation of stocks. Net buys exceeded $20 billion in six years between 2008-09 and 2020-21.

After the National Democratic Alliance (NDA) won the national elections in 2014, foreign portfolio investors increased their exposure to India and net bought securities worth $40.92 billion that financial year. They were net sellers in just two years, 2015-16 and 2018-19.

Foreign direct investments

Many policymakers prefer FDI to foreign portfolio investment for several reasons. Firstly, it is considered more durable – investors are willing to ride out uncertainty in the political and business environment. Secondly, FDI usually results in the transfer of knowledge and technology to host countries.

India received $468.88 billion worth of net FDI between 2009-10 and 2020-21, which included reinvested investment and other capital flows. In 2020-21, the country received net FDI worth $54.93 billion – a significant part of which was brought in by investors that bought into Reliance digital and retail businesses. However, 2019-20 was the best year for FDI inflows into the country, foreigners invested $56 billion in the country.

Remittances from overseas workers

India has been the highest recipient of remittances from overseas workers for a long time. Between 2009-10 and 2020-21, India received an estimated $450 billion as net remittances from non-residents working overseas.

Net inflows climbed to $56.19 billion in 2019-20 and then declined to $50.25 billion in the pandemic year. Workers remittances are not the only form of transfers that happen between residents and non-residents. Non-resident deposit is another mode of transferring money to residents. But remittances account for a bulk of such transfers, referred to as personal transfers.

The sum of personal transfers between 2009-10 and 2020-21 was an estimated $750 billion. Transfers from residents to non-residents also take place. For instance, households transfer money to their wards studying in universities overseas.

Software and other services exports

Exports of software services have been the most stable source of forex earnings for the country. India earned as much as $827.45 billion by providing information technology and information technology-enabled services between 2009-10 and 2020-21.

Net export earnings from IT and ITeS rose steadily over the years. The Balance of Payments statement shows that net export earnings climbed to $90.80 billion in 2020-21 from $85.90 billion in the preceding year.

Other services

Inbound tourism and some business services have also been foreign exchange generators traditionally. Tourism suffered in 2020 due to travel restrictions imposed by several countries.

Among various business services exported, professional and management consulting services have been net foreign exchange-earners. However, outgo on some other business services almost equals the receipts from professional and management services, leaving a negative balance under this head in several years.

Merchandise trade

One measure of the adequacy of foreign exchange reserves was the number of months of import cover it provided. That’s one count on which India does not have to worry, even if there is a flight of portfolio investors from India’s stock markets.

India imports exceed exports given its high dependence on imported crude oil. Gold is another top item of import. As a result, India runs a negative trade balance for merchandise. This negative trade balance is financed by the forex reserves. Between 2009-10 and 2020-21, India spent about $1,766 billion on the trade deficit.

A narrower trade balance means a lower drawdown of the foreign exchange pile, as had happened in 2020-21 when global trade contracted. The trade balance had widened the most in 2012-13 to $195.66 billion when gold imports soared.

The repatriation of investment income as dividends and interest also result in a drawdown of foreign exchange reserves. Large sums are transferred out from India by direct and portfolio investors every year.

Similarly, investors and licensees of intellectual properties repatriate royalties and other charges. Investments and acquisitions made by Indian companies overseas also result in a drawdown of foreign exchange reserves.

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