High Trade Deficit, Yet Massive Forex Reserves. How Does India Manage it?

By: Aashna Mishra

The “Vote of confidence” from foreign investors and the resulting rise in reserves are viewed as a positive signal regarding India’s external sector.

As per the data published by the Reserve Bank of India (RBI) recently, India’s foreign exchange reserves reached an all-time high of $675 billion on August 2, 2024. In conformity with the Weekly Statistical Supplement released by the RBI, Foreign Currency Assets increased by $5.1 billion to $592.04 billion. Clearly, India’s strong position amidst global economic challenges, supported by strategic policy measures and prudent monetary policies, has resulted in forex reserves reaching an unprecedented high of $675 billion. According to Sanjeev Agrawal, President of the PHD Chamber of Commerce and Industry, this milestone reflects the country’s resilience in navigating global uncertainties and underscores the efficacy of its monetary and fiscal policies.  

As specified by Bloomberg Compiled Data, approximately $550 million flowed into the country’s bonds during the week of July 5, 2024. Offshore inflows of about $1.1 billion were seen in the stocks during the same period, as the country’s macroeconomic stability enhanced the appeal of its assets to foreign investors. Additionally, a low merchandise trade deficit and higher receipts from exports, transfers, and services, especially remittances from workers abroad contributed to these improvements.  

According to the RBI, in spite of the rising trade deficits and solidifying crude prices weighing on the downside, robust capital inflows have helped the rupee gain value. . Correspondingly, the currency hedging costs have gone down than before. Amidst large capital inflows, moderation in the current account deficit (CAD) accredited the addition of foreign exchange.   

In the same financial year, net foreign direct investments totaled $9.8 billion, while portfolio inflows amounted to $44.1 billion, and net inflows of banking capital (including NRI deposits) reached $40.5 billion. These capital receipts exceed the sums required to finance the current account deficit, allowing India to accumulate the surplus inflow as foreign exchange reserves, which expanded by approximately $64 billion after adjusting for valuation changes.  

Last September, JP Morgan set forth an incorporation of government papers issued by RBI under the completely attainable route within the extensively tracked GBI-EM. This 10-month incremental inclusion of the bonds ending by March 31, 2025, will gradually increase India’s bonds’ weight 1 percent every month, thus attaining a 10 percent weightage. The expected inflow into the Indian bond market because of this inclusion is approximately $20-22 billion which would further strengthen the forex reserves. Furthermore, Rs. 15,352 crore worth of inflows were seen in the domestic equities during the same period.  

The “Vote of confidence” from foreign investors and the resulting rise in reserves are viewed as a positive signal regarding India’s external sector. Analysts suggest that the RBI’s assimilation of dollar inflows will likely prevent a sharp appreciation of the rupee, despite higher levels of growth and a favourable balance of payments. Consequently, with this increase in forex reserves, India is now better positioned to manage currency volatility and maintain economic stability amidst global uncertainties. This growth not only reflects the success of India’s economic policies but also highlights the impact of reforms that are aimed at driving foreign investments and thus boosting the level of exports.