Forex reserves hit record $740.8 billion following strong FCNR (B) inflows

The reserves rose $11.48 billion during the week, after having jumped $12.42 billion to a then-record $729.33 billion in the previous week, according to RBI data. The latest level is an all-time high for India’s headline gross foreign exchange reserves in nominal dollar terms. 

The previous major peak was $728.49 billion in the week ended February 27, immediately before US-Israeli strikes on Iran on February 28 triggered a wider West Asian conflict and severe volatility in global energy markets.

The subsequent surge in oil prices and pressure on the rupee prompted heavy RBI intervention. Reserves fell by almost $11.7 billion in the week ended March 6 alone as the central bank sold dollars to limit disorderly depreciation in the currency. 

In March, the RBI sold a net $9.76 billion in the spot foreign exchange market, while its outstanding forward dollar sales also rose sharply. Since late June, however, the direction has reversed. Reserves have now risen for nine consecutive weeks, adding nearly $75 billion over the period.

FCNR(B) rush changes the equation

A major driver of the turnaround has been the RBI’s special foreign exchange mobilisation programme launched in June, particularly the Foreign Currency Non-Resident (Bank), or FCNR(B), deposit window.

FCNR(B) deposits allow non-resident Indians to place money with Indian banks in specified foreign currencies rather than converting the funds into rupees. This protects the depositor from movements in the rupee during the life of the deposit.

The RBI introduced a special dollar-rupee swap facility on June 8 for fresh FCNR(B) deposits with maturities between three and five years. Under the arrangement, banks could hand over the dollars raised from NRIs to the RBI and receive rupees in return. At the end of the agreed period, the transaction reverses.

The mechanism matters because banks would normally have to hedge the currency risk themselves. By providing the swap on favourable terms, the RBI substantially reduced that cost and made it easier for banks to offer attractive dollar deposit rates overseas.

The central bank also exempted eligible fresh FCNR(B) deposits from cash reserve ratio and statutory liquidity ratio requirements, further improving the economics for banks.

The response substantially exceeded initial expectations.

Banks mobilised about $127.22 billion through FCNR(B) deposits by August 31, according to the latest provisional data. Another $5.26 billion came through overseas foreign currency borrowings (OFCBs), while external commercial borrowings (ECBs) brought in $3.89 billion.

That took total mobilisation under the three special routes to about $136.37 billion. This is considerably higher than the roughly $80 billion that RBI Governor Sanjay Malhotra had expected as recently as August 20.

RBI closed FCNR(B) window early

The RBI had initially allowed banks to mobilise deposits eligible for the FCNR(B) swap facility until September 30.

But with inflows accelerating rapidly, the central bank brought forward the deadline to August 31, saying the facility had received an encouraging response. At the time the early closure was announced on August 14, FCNR(B) mobilisation stood at only $52.3 billion.

That means roughly $75 billion more was mobilised between mid-August and the closure of the window, illustrating how heavily flows were concentrated towards the final weeks of the scheme.

Banks can still conduct RBI swaps against eligible FCNR(B) deposits already mobilised until September 11. The separate facilities covering eligible ECBs and overseas foreign currency borrowings remain open until December 31.

Not all $136 billion becomes reserves

The $136-billion mobilisation should, however, not be read as a $136-billion addition to India’s forex reserves.

The two numbers measure different things.

The mobilisation figure captures foreign currency raised by banks and borrowers through the schemes. The reserve number reflects foreign assets actually held on the RBI’s balance sheet after accounting for its market intervention, valuation changes and other transactions.

Why reserves jumped this week

Foreign currency assets, the largest component of the reserves, rose $9.34 billion to $600.67 billion in the week ended August 28. Foreign currency assets do not consist only of US dollars. India also holds assets denominated in currencies such as the euro, pound and yen. 

The RBI reports their combined value in dollar terms. Changes in exchange rates can therefore raise or lower the reported value of reserves even when the quantity of underlying assets does not change.

Gold reserves rose another $2.19 billion to $116.41 billion.

Special Drawing Rights, or SDRs, declined $43 million to $18.81 billion, while India’s reserve position with the International Monetary Fund fell $11 million to $4.91 billion.

Interestingly, the value of India’s gold reserves remains below the $131.63 billion reported at the February reserve peak. The new overall record has instead been made possible largely by the much larger stock of foreign currency assets. 

At the February 27 peak, total reserves stood at $728.49 billion, of which foreign currency assets accounted for $573.13 billion. By August 28, foreign currency assets had risen to $600.67 billion, helping push the overall reserve stock to a new record of $740.80 billion despite a lower value of gold holdings.

Dollar inflows may create a liquidity concern

The same inflows that have helped rebuild the forex buffer have also injected a large amount of rupee liquidity into the banking system. 

System liquidity moved from a surplus of about Rs 1.6 lakh crore initially to Rs 6.7 lakh crore by the end of August and further to Rs 9.7 lakh crore as of September 2, Bank of Baroda economist Aditi Gupta told The New Indian Express.

The mechanism is straightforward: when banks swap dollars with the RBI, the central bank receives the foreign currency and provides rupees in return.

The RBI has consequently been absorbing part of this surplus through variable-rate reverse repo, or VRRR, auctions. Gupta said the central bank had announced VRRR operations totalling Rs 53.5 lakh crore between August 6 and September 2.

The challenge for the RBI has therefore changed considerably in a matter of months. Earlier this year, it was drawing on reserves to contain disorderly rupee depreciation. It is now rebuilding the forex buffer rapidly while simultaneously managing the rupee liquidity generated by strong foreign-currency inflows.