Foreign exchange reserves have been depleting fast over the past five months and are currently at a three-year low. At $274.8 billion, the country’s reserves are at levels last seen in June 2010.

Since the beginning of this year the reserves have shrunk 6 per cent, mainly due to forex market intervention and foreign investor pullout from debt assets.

With the rupee hitting a life-time low of 68.8 against the dollar last month, foreign exchange reserves have become an important number to track.

They reflect the amount of resources the central bank has at its disposal to intervene in the foreign exchange market to support the rupee.

When the rupee is declining, the central bank needs to sell dollars to increase its supply, thus bringing down the dollar-rupee exchange rate.

These sale of dollars as part of currency intervention seem to have depleted the forex reserves.

Latest data released by the central bank shows that it sold (net) $2.2 billion in the forex market in June and almost $6 billion in July. Since the rupee entered an extremely slippery phase in August, dollar sales in this month is also likely to be quite high.

The FCNR (B) swap facility announced by the RBI recently, which is expected to bring in close to $10 billion, could help shore up some of the foreign exchange reserves.

Another reason for the depletion in reserves is the pullout by foreign institutional investors in debt and equity markets. According to SEBI, FIIs have sold (net) $12 billion worth of equity and debt since June. They still hold $138 billion in equity and $27 billion in debt.

These funds still pose a risk. According to RBI, the ratio of volatile capital flows (defined to include cumulative portfolio inflows and short-term debt) to the reserves increased from 83.9 per cent as at end-September 2012 to 96.1 per cent as at end-March 2013.

Reserve revaluation

Another reason for depletion in forex reserves is the revaluation of assets. Forex reserves have taken a hit due to the gold held in these reserves, which account for 7 per cent.

The country currently holds 557.75 tonnes of gold in its reserves, valued at $20 billion. The value of this holding is down 25 per cent since the beginning of this year.

Foreign currency assets account for $250 billion or 90 per cent of the forex reserves. This segment of reserves is down 4 per cent since January.

These assets are maintained in major currencies such as US dollar, euro, pound sterling, Japanese yen and so on but are expressed in US dollars.

As the dollar has gained against all the major currencies since the beginning of this calendar, the erosion in this segment appears mainly on account of a reduction in foreign currency assets, and not due to revaluation.

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