India's foreign exchange reserves rose by $12.8 billion to $572.8 billion on March 17, 2023, touching a 6-week high, shows the recent data released by the Reserve Bank of India (RBI) . At a juncture when financial markets worldwide are facing intense pressures and extreme risk aversion due to the recent Silicon Valley Bank (SVB ) collapse and Credit Suisse crisis, economists decode what it means for the Indian economy to have robust forex reserves.

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Why is Forex Reserve important?

 

Forex reserve is one of the major parameters to measure the country’s economic growth. As pointed out by economists, adequate forex reserves not only help countries fight or overcome economic instability, they also help maintain the stability of the domestic currency. Moreover, the adequacy of reserves helps gain the confidence of investors in times of extreme uncertainty, such as wars or unrest, portrays a positive image, and reassures trading countries. 

 

With India’s forex reserves touching a 6-week high, economists explain what it means for the Indian economy and its growth trajectory.
 

Better Growth Differential

 

The forex reserves reflect the pace of economic growth of a country, pointed out economists. “If people believe that over the medium term, in the next three to five years, a country will be growing faster than the rest of the world, it becomes inevitable that people will be investing in that economy. Any economy that is growing faster than others, people will flock to the economy and money will come via FDI or portfolio, or both. This economy is going to be growing at 6-7 per cent real term, so basically Indian economy will be doubling every six years,” added Sachchidanand Shukla, Chief Economist at Mahindra Group.

 

Standing out among South-Asian Countries

 

In recent times, two neighboring countries of India — Sri Lanka, and Pakistan — have faced severe economic crisis due to their depleting forex reserves. As highlighted by economists, countries try to protect the economy by selling dollars out of reserves and get into a trap, with no private money left. So even if the governments then want to buy oil or import products, they don’t have the money. “If the forex reserves dwindle, the ability to purchase critical things like oil and some food items they don’t produce, reduces, as they don’t have enough dollars to pay for it. Then the country faces shortages of necessary items, inflation, and eventually, the entire economy breaks down, which we have seen in Sri Lanka and Pakistan. As reserves start dropping, a lot of investors started taking money out of such countries,” said Abheek Barua, Chief Economist at HDFC Bank. With a strong forex reserve, India stands out not only among its Asian peers, but also on a global level.  

 

China vs India

 

Despite India and China being the two largest economies in Asia, there is a disparity between the forex reserves of the two economies. China's foreign exchange reserves stood at USD 3.133 trillion at the end of February 2023. However, economists pointed out that the growth pace is slower in China, so India is likely to gain more confidence among investors as an emerging economy. “This is the first time that a major economy is growing faster than China. This has not happened in the last 30 years,” Shukla added. 

 

Less spillover impact

 

When there are economic crises in the USA or Europe, the worries and anxieties don’t remain confined to particular countries. There is a spillover impact on the financial institutions of other countries as well. People start selling stocks from these institutions and taking their money out from other assets and bonds. During such a time, a country with strong forex reserves helps build the investors' trust, opined economists. “If there is a crisis, even if it seems remote like the SVB crisis, it has a spillover effect. But the ability to handle that impact, without getting into a bad situation is directly proportional to the amount of reserves the country has, ” Barua added. 

 

Indian currency not under pressure

 

Economists highlighted that, in the past, Indian Rupee came under pressure whenever there was a global liquidity accident. “If you look at debt to GDP, the fiscal deficit is coming down, inflation differential is not much and with growth potential, Indian matrix remained favourable despite some major global issues happening currently. But now, despite the crises (SVB and Credit Suisse), the Indian currency has not come under much pressure,” Shukla asserted.
 

Gaining confidence among investors

 

After Russian invasion of Ukraine in 2022, most of the investors migrated to a ‘safe haven’, which is essentially the US market. However, with recent collapses in the banking industry in the USA, there have been some growing concerns among investors too. In such a situation, India may emerge as a favourable country for investors. Economists say that, although India can’t replace the USA as the "safe haven", it will surely become one of the most favoured countries after the USA for investors. 
 

Are all the concerns over for the Indian economy?

 

Despite growing forex reserves, economists cautioned that the level of forex reserves can fall as India witnessed a fall of $70 bn in 2022 due to a combination of factors such as foreign investors pulling out money, and heavy RBI intervention to control currency volatility. Thus, the RBI has to consider financial market conditions, the impact of imported inflation, and the acute shortage/ excess of US dollars in the market and accordingly decide to sell/ buy US dollars to keep the Rupee from depreciating/ appreciating sharply.