India’s foreign exchange reserves, which recently crossed the $600-billion mark for the first time, maybe deceptive as it will be adequate to finance less than 15 months’ actual imports in FY22 against 20 months’ at current levels, a Reserve Bank of India research paper has said.
“In terms of projected imports for 2021-22, the current level of reserves provides cover for less than 15 months, which is lower than for other major reserve holders,” warns the paper authored by RBI deputy governor Michael Patra and his team of economists published in the central bank’s latest monthly bulletin.
The import cover — the number of months’ imports that the reserves can finance — at current levels of imports and reserves is estimated at 19.6 months.
The RBI amassed $100 billion in just about 12 months despite the pandemic-induced lockdown disrupting economic activity globally. This is the fastest pileup in reserves since the global financial crisis.
The reserves are at a record $605 billion as of June 4, the latest official data indicates, and India is now the fifth-largest holder of forex reserves. Even at these levels, the reserves’ cushion may not be a very comfortable one.
Other major foreign exchange reserve holders have higher import cover, led by Switzerland with 39 months’ cover, followed by Japan (22 months), Russia (20 months), and China (16 months), the RBI paper said.
A surge in imports is factored as prices of crude, which accounts for a fifth of India's import bill, and other commodities are rising. India’s merchandise imports grew by more than 50% in May 2021 due to a low base a year ago.
“As compared to the lockdown a year ago, the recent restrictions have had a limited impact on import demand,” the paper said.
Besides meeting importers’ demand, forex reserves would be also needed for servicing external debt. “While foreign exchange reserves provide cushions against unforeseen external shocks, levels are often deceptive, and a better gauge of external vulnerability is an assessment of specific indicators,” the paper said.
In terms of external vulnerability indicators, as of December 2020, reserves were 104% of the total external debt of $536 billion, short-term debt in terms of residual maturity of up to less than a year are about 43% and external debt to GDP is at 21%.
All these indicators do not cause alarm on the face of it. But the catch is that India’s external liabilities far exceed its external assets.
“India’s reserves coexist with a net international investment position of (-)12.9% of GDP. These factors warrant a pragmatic assessment of reserve adequacy on FX reserves, including exposure to valuation changes and market risk in a world of heightened global uncertainty,” the paper said.