Biggest global currency drop in 20 years: Here’s what it means for India’s economy

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The decline in the global currency reserve in the second quarter of 2022 was the largest compared to the same quarter a year earlier, recent data from the International Monetary Fund (IMF) shows. According to various economists and forex experts, central banks around the world have dipped into foreign exchange reserves to avoid a sharp depreciation of their respective currencies.

Global currency reserves have mostly shown an upward trend over the years, quarter over quarter. But the drop was the highest in the past 20 years, dropping more than 6% (TQ) in 2022, as it hit $12 trillion. As various economists have pointed out, the reserves of most economies fell faster than the Lehmann crisis and the Taper Tantrum.

Factors contributing to the fall

The main factors behind the decline in foreign exchange reserves stem primarily from a stronger dollar, various economists have said.

“On the one hand, the strengthening of the dollar leads to a decline in the value of reserves. This is the valuation effect. On the other hand, most global currencies have been under pressure due to the rising dollar. As a result, the central banks of several countries, including Japan and India, have been actively intervening in the foreign exchange market by selling dollars from their respective forex pool,” added Aditi Gupta, an economist at Bank of Baroda.

At the same time, hopes of aggressive rate hikes from the Fed and growing risks of a global recession have fueled risk aversion sentiment and contributed to the recent strengthening of the dollar. This has further led to the fall in global foreign exchange reserves.

The foreign exchange reserve is intended to finance the rise in oil and gas in general and in part for US investments in their bonds which now offer higher yields, experts added.

Impact on Indian economy

India also lost $57.7 billion during Lehmann and $21.6 billion during the tantrum, but the loss has been much more for India recently. The foreign exchange reserve fell by $4.85 billion to $532.66 billion for the week ending September 30, according to data released by the Reserve Bank of India in the first week of October.

Although the country has a better reserve of foreign exchange compared to other countries, the vulnerabilities that India is likely to face cannot be ignored, economists and forex analysts have said.

“India’s position in terms of foreign exchange reserves is quite stable. Foreign exchange reserves are sufficient to cover 9 months of imports,” added Swati Arora, Economist, HDFC Bank.

As a country, India is the most vulnerable to a rise in oil prices since 83% of the country’s oil is imported. So any rise in oil prices increases there will be an impact on FEX reserves and hence there will be a hit on the Rupee. “This time, RBI had been continuously buying dollars since 2020 and accumulating reserves worth $147 billion since then until September 21. He used these reserves wisely to protect the rupee, which resulted in the weakest fall for the currency compared to many others. Asian currencies which fell 12-20%,” added Anil Kumar Bhansali, Head of Treasury, Finrex Treasury Forex.

Moreover, according to the latest RBI data, at the end of June 2022, India’s short-term debt to foreign exchange reserves ratio was 22%, which is below historical trends and there is no therefore no threat to the servicing of the external debt.

RBI has enough arsenals in its quiver to prevent any massive depreciation like in 2013, but rising oil prices and falling exports will not change its direction, according to various economists.

Despite declining reserves, India should maintain a relatively safer position. “India’s top 5 trading partners are also the United States, China, the United Arab Emirates, Hong Kong and Singapore. These countries have comfortable import coverage rates. Therefore, a drop in the global foreign exchange reserve will not impact India,” added Dr. Sudarshan Bhattacharya, Senior Economist at Yubi (formerly CredAvenue), a corporate debt solutions company.

Foreign exchange reserves and liquidity

Banking system liquidity in India has recently declined as part of RBI’s efforts to absorb excess liquidity from the banking system post Covid-19. The RBI’s forex intervention complemented other tools to mop up excess liquidity from the banking system as the RBI sold the dollar and bought rupees in the foreign exchange market, economists said.

“If the RBI reduces the pace of forex interventions in the future, it will be able to absorb excess rupee liquidity from the banking system at a slower pace, in which case there will be an accumulation of excess liquidity. in the banking system as government spending increases should be significant in S2FY23 which will see greater liquidity in the banking system,” Bhattacharya added.

What awaits us?

The extreme aggressiveness of the Fed and the resulting rally in the dollar led to the reduction in reserves. Also, most of the reserves are stored in treasury bills and the MTM (market to market) on the same has been a huge drawdown.

“As US bond yields begin to fall again, central bank reserves will automatically stop shrinking and even start to strengthen. reversals in global markets and eventually reserves will also stabilize,” said Saurabh Goenka, CEO and Managing Director of Zenith FinCorp.

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