Crucial reserves. Preserve foreign reserves to deal with worse outflows, turmoil in future, IMF tells countries

Without naming any country specifically, the International Monetary Fund (MF) has advised countries to preserve their vital foreign reserves to deal with potentially worse outflows and turmoil in the future. The advice comes at a time when the Reserve Bank of India (RBI) has spent over 100 billion dollars in the last one year to defend the Indian rupee against the US dollar.

India’s forex reserves, which hit an all-time high of $642.45 billion in the week ending September 3, 2021, dipped to $532.66 billion as on September 30, 2022. The rupee is currently trading above the 82-level against the US dollar.

A blog by Gita Gopinath (First Deputy Managing Director, IMF) and Pierre-Olivier Gourinchas (Economic Counsellor, IMF), titled ‘How Countries Should Respond to the Strong Dollar’, highlighted that on an average, the estimated pass-through of a 10 per cent dollar appreciation into inflation is 1 per cent. “Such pressures are especially acute in emerging markets, reflecting their higher import dependency and greater share of dollar-invoiced imports compared with advanced economies,” it said. The dollar against the Indian rupee has appreciated around 8 per cent during the year. Retail inflation based on Consumer Price Index (CPI) is at 7.41 per cent.

According to the blog, the dollar is at its highest level since 2000, having appreciated 22 per cent against the yen, 13 per cent against the euro and 6 per cent against emerging market currencies, since the start of this year. “Such a sharp strengthening of the dollar in a matter of months has sizeable macroeconomic implications for almost all countries given the dominance of the dollar in international trade and finance,” it reminded.

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While the US’ share in world merchandise exports has declined from 12 per cent to 8 per cent since 2000, the dollar’s share in world exports has held around 40 per cent. For many countries fighting to bring down inflation, the weakening of their currencies relative to the dollar has made the fight harder. As world interest rates rise, financial conditions have tightened considerably for many countries and a stronger dollar only compounds these pressures, especially for some emerging market and many low-income countries that are already at a high risk of debt distress, it added.

The blog advised: “Countries must preserve vital foreign reserves to deal with potentially worse outflows and turmoil in the future.” Further, those that are able should reinstate swap lines with advanced-economy central banks. Countries with sound economic policies in need of addressing moderate vulnerabilities, should proactively avail themselves of the IMF’s precautionary lines to meet future liquidity needs, it said.

Meanwhile, HDFC Bank in a note says India has enough ammunition to intervene in the forex market. In the note titled ‘Navigating the perfect storm,’ the bank says RBI’s FX strategy has focussed on allowing rupee depreciation in line with other currencies and the dollar rise, and instead curtailing sharp volatility or a free fall in the rupee. “The RBI continues to have adequate FX reserves (despite the drop in the level of reserves, the import cover is close to 9 months and is likely to get support as imports also start declining over the coming months) and enough ammunition to intervene in the FX market,” it said