The country's forex reserves are expected to hit $400 billion by September, driven by robust capital inflows and weak credit offtake, says a Morgan Stanley report.

According to the global financial services major, Indian forex reserves are at an all-time high and have increased at the fastest pace since 2015. As of August 4, forex reserves had hit a record high of $393 billion.

“If the pace of forex reserves is similar to that of the past four weeks, forex reserves would hit $400 billion by September 8, 2017,” Morgan Stanley said in a research note, adding “the gain in India’s forex reserves has been one of the strongest within the Asia, ex-Japan region, in the past 12 months“.

Morgan Stanley, attributed two major reasons for rise in forex reserves —— robust capital inflows and weak credit offtake.

“Foreign direct and institutional flows remain robust, tracking at $63 billion and $17 billion on a 12-month trailing sum basis. This robust inflow coupled with weak credit offtake has meant interbank liquidity remains in strong surplus mode of $42 billion,” Morgan Stanley said.

The report, however, noted that as capital flows remained buoyant, it would put appreciation pressures on rupee and could lead to excess liquidity, which in turn would create challenges for the RBI to manage its monetary policy.

But RBI is not likely to cut policy rates and lower real rates to prevent further currency appreciation, as the central bank is following a flexible inflation targeting regime, the report said.

“Hence, RBI monetary policy will only take into account the impact of currency appreciation on inflation into its policy decision, rather than tackling currency appreciation per se,” Morgan Stanley said.

RBI has already intervened in the currency markets in both spot and forward market to the tune of $3 billion and $17 billion, respectively, as of June 2017.

The report noted that as the excess liquidity challenge looks set to persist, RBI will need more tools to manage excess liquidity.