Let’s discuss why the RBI is buying more and more INRs, causing forex reserves to fall

The News

India’s forex reserves have declined by over $48 billion from its all-time high of $704.89 billion (on Sep 27). Last Friday, the RBI data showed that as of Nov 22, our forex reserves have fallen to $656.58 billion.

The RBI publishes the forex reserve data every Friday, and in the week ending Nov 15, the country’s forex reserves declined by $17.76 billion—the sharpest weekly fall ever.

The previous highest weekly fall in forex exchange reserves was $15.5 billion, recorded for the week ended October 24, 2008, during the global financial crisis.

India's Forex Reserves in past one year

Why are reserves falling?

In one line, if we have to say, the RBI is buying INR and selling USD. Intriguing, right? Why the RBI is buying its domestic currency by using foreign currencies? Let me tell you.

In the past two months (Oct & Nov), foreign investors have sold ₹1.6 lakh crores worth of Indian equities.

When these foreign investors exit their INR-denominated investments, they convert INR into their domestic currency. To do this, they sell INR and buy their domestic currency.

This increases the supply of INR in the market, putting downward pressure on its value. As a result, the value of INR falls against other currencies.

But that’s only half the problem. USD is also getting stronger after Trump’s re-election, creating a double whammy for the INR.

This is where the RBI steps in. Using its forex reserves—which include USD, Euros, Yen, and other foreign currencies—the RBI buys INR from the market. It helps stabilize the INR to some extent, reducing its freefall and managing currency volatility.

Now, it might seem like a desperate attempt. But if you look, despite this move, INR has hit an all-time low against USD, with $1 = ₹84.69.

Why is it important to do it?

Apparently, by doing this, the RBI is trying to help every common man. Here’s how:

  1. Costlier Imports:
    A weaker currency increases the cost of imported goods, specifically crude oil, which increases the cost of everything else, pushing up domestic inflation.
  2. Uncertainty for businesses:
    A volatile currency makes it difficult for importers, exporters, and multinational corporations to plan their budgets. This uncertainty discourages investment and trade.

So the RBI intervention helps both—businesses and consumers.

Has it happened before?

Well, yes. Back on 4th March 2022, India’s forex reserves were above $630 billion. But then, it started falling.

During the COVID-19 lockdown, economic activity slowed down globally. To support growth, countries, including USA, lowered their interest rates.

However, by early 2022, as economies began recovering, it was time to tackle inflation. US Fed started increasing interest rates, making US bonds more attractive to investors.

This led to money flowing out of countries like India, putting downward pressure on INR. To support the falling INR, the RBI came to the rescue.

As a result, India’s forex reserves took a hit. Between March 2022 and October 2022, they dropped from $630 billion to $525 billion—a fall of over $100 billion in just eight months.

To Conclude

The RBI’s intervention in the forex market is a balancing act to protect the economy from the ripple effects of a depreciating INR.

While it might deplete our forex reserves in the short term, the goal is to stabilize the currency and shield the country from rising inflation and economic uncertainty.