A surge in India’s foreign reserve stock has led to questions on what the RBI will consider as an ‘adequate’ level. Our reading of the tea leaves suggests there is further headroom for the stock to grow.

India’s total foreign reserves surpassed and stayed above $700 billion as of October 2024, only the fourth country in the world to do so. Foreign securities dominate the reserves mix, alongside positive returns from higher coupon deposits with global central banks also boosted the nominal reserve levels. Net dollar purchases jumped by $29 billion between January and July 2024, before likely moderating in Aug-September 2024 due to intervention to prevent one-sided rupee depreciation.

Gold holdings

The central bank also joined its peers in rebuilding its gold holdings, with the latter’s share rising to over 9 per cent of the overall stock vs 6 per cent in late-2019. Gold prices surged last quarter, provided positive valuation tailwinds. On a comparative basis, India’s reserve stock has risen by the most amongst its regional peers since the 2013 taper tantrum.

There is some time to go before authorities pull the brake on reserve accumulation, on three counts.

Firstly, strong portfolio inflows and BoP surplus. With the balance of payments expected to post a surplus on the back of strong financial flows, and manageable current account deficit, helped by resilient remittances and strong services receipts, further net accretion is likely in the reserves position.

In 2QFY (Jul-Sep 2024), the goods trade balance may experience some challenges due to a temporary increase in gold purchases and festive import demand, potentially leading to a wider CAD of approximately -1.6 to -1.8 per cent of GDP.

However, this is expected to stabilise in the following quarter as lower oil prices are reflected in the energy import bill and a sustained services surplus continues. Geopolitics induced jump in oil prices is an unknown in this mix.

A manageable CAD is likely to be accompanied by favourable funding terms. While direct investments might be steady, portfolio inflows have maintained a strong streak on FYTD basis, with cumulative flows into the debt and equity markets at over $20 billion by end-September.

Adding non-resident deposits and external commercial borrowings, we expect FY25 BoP to register $48-$50 billion surplus vs $63.7 billion in FY24, underpinning reserves.

Secondly, reserve adequacy ratios are well-buffered but below peak levels. Total reserves are well-cushioned across various adequacy ratios, including imports coverage, IMF’s ARA metrics, external debt ratios particularly short-term debt and our proprietary GEFR (gross external financing ratio).

India’s import cover (reserves vs months of imports) at 10-11 months is not only three times above the global norm, but also consistent with the 3-7x seen across most developing countries. This strengthens the authorities’ defence against external shocks or uncertainties.

More headroom

While metrics are at healthy levels, few of the ratios are below their past peaks. For instance, import coverage taken as a proportion of either total reserves or foreign currency assets, is below peak levels witnessed a decade back.

Similarly, the GEFR gauge is well above the 2013 taper tantrum period, but below stronger levels witnessed in wake of the pandemic. These suggest there is further headroom for reserves accumulation.

Lastly, reserve accumulation is driven by flows. Just as foreign exchange reserves have risen, so have external liabilities.

Consequently, the overall net international investment position remained in red last year and likely in FY25, but encouragingly narrower than 2018-19. On the assets side, reserves jumped sharply, but this was counterbalanced by a jump in liabilities, primarily in the form of higher foreign portfolio investments alongside increase in offshore borrowings.

Even as authorities are focused on building buffers against external headwinds, the stock could be at risk if the global environment worsens, as the reserves composition has been a function of fluctuant portfolio flows, rather than stickier current account surpluses through trade. This reinforces our expectations that the overall tendency will be to continue building ammunition.

With the government’s intention to build a strong war chest to fend against global uncertainties, we expect the stock to near $725-$730 billion by fiscal year end.

The writer is Senior Economist & Executive Director, DBS Bank, Singapore