India's forex reserves declined by USD 1.268 billion, falling to USD 561.583 billion for the week ended January 6, the data released by the Reserve Bank of India showed on Friday. This comes a day after the inflation numbers brought some relief to the Indian economic situation.  

The overall foreign exchange reserves had increased by USD 44 million to USD 562.851 billion in the previous week after witnessing fall for two consecutive weeks. 

In October 2021, the country's foreign exchange kitty reached an all-time high of USD 645 billion, witnessing one of the highest jumps in the last one year. The reserves had been declining as the central bank deployed the reserves to defend the rupee amid pressures caused by global developments.

Foreign currency assets (FCA), a major component of the overall reserves, dropped by USD 1.747 billion to USD 496.441 billion during the week to January 6, according to the Weekly Statistical Supplement released by the RBI.

Economists point to these two major reasons behind the fall in forex reserves: 

1.       Growing dollar volatility  

Economists expressed concern about further decline in the forex reserves in the coming months as they suspect the dollar index to remain volatile.

“The dollar index to remain volatile in the near-term but expect a decline to set in once the Fed pauses. The Fed is to pause at 5-5.25% and we expect a lower chance of any rate cuts in 2023. The US bond yield curve could steepen,” added economists of HDFC Bank.  

Expressed in dollar terms, the foreign currency assets include the effect of appreciation or depreciation of non-US units like the euro, pound, and yen held in the foreign exchange reserves.

2.       Economic recovery in China  

Economists pointed out that the gradual recovery of China's economy from the massive economic doldrums triggered by the Covid pandemic is another major reason for India’s falling reserves. China reopening could lead to renewed interest from foreign investors, leading to a shift of funds from India to China.

“China re-opening effect surprises and is stronger than what we have priced in – leading to a greater risk of foreign flows rotating out of India to China and the extent of the increase in commodity prices is also higher. Also, this could raise global inflationary risks yet again,” added Sakshi Gupta, senior economist at HDFC Bank.