India's forex reserves fall to $398.8 billion

 

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It is important to remember that the reserves have been accumulated due to the central bank's constant intervention in the market.

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In India, Foreign Exchange Reserves are the foreign assets held or controlled by the country central bank. The reserves are made of gold or a specific currency. They can also be special drawing rights and marketable securities denominated in foreign currencies like treasury bills, government bonds, corporate bonds and equities and foreign.

So much so over the past year that currency dealers say the biggest buyer of the dollar in the market is the RBI, overshadowing the traditional big buyers, the oil marketing companies. Had the RBI not intervened in the market to buy dollars, the rupee would have reached a dollar, wiping out India's export competitiveness. According to Hitendra Dave, HSBC's head of global markets for India, dollar flows are unlikely to see a meaningful slowing in the near term and, therefore, the chance of rupee depreciation is less.

Besides, say currency dealers, if the central bank tries to actively depreciate the rupee, foreign investors would pour in more money, betting that they would be repatriating their investment at a time when the rupee would be stronger than their entry point. That would be a never-ending cycle for the central bank, at a time when global liquidity is awash and places to invest the money are fewer.

Hence, it is unlikely that the reserves could be used to soften the exchange rate. At a time when India is attracting good investor interest, the reserves would continue to rise and the rupee to strengthen.

A strong rupee helps bring down imported inflation, as well as reducing the external debt. At at a time when the central bank is pursuing an inflation targeting framework, a relatively strong rupee is in the interest of the central bank. Generally, every country tries to accumulate enough of forex reserves to maintain a certain number of months' import cover.

However, that is also coming under more scrutiny. The International Monetary Fund IMF maintains that the appropriate level of reserves cannot be determined without reference to the capital account. There is a weak relationship between reserves over imports and the occurrence or depth of crises, says IMF. But, there are debates on whether three months of import cover is a good indicator or, say, eight months. The central bank revealed in its report for that it earned a return of 0.

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