Higher foreign exchange reserves reduce the cost of foreign borrowing and the cost of hedging: RBI article

Higher foreign exchange reserves have reduced the cost of foreign borrowing as well as the cost of hedging for businesses, according to an article in the RBI Monthly Bulletin.

Since 2019, the RBI has accumulated foreign exchange reserves which peaked at USD 642.453 billion in the week ending September 3, 2021, more than double the reserves at the end of December 2018.

At the peak, reserves were sufficient to cover 18 months of imports. Foreign exchange reserves have been measured in terms of import cover, which is no longer the criterion.

However, reserves fell by $14.272 billion in March 2022 alone as the rupiah came under pressure from capital outflows following rising interest rates in advanced economies and the Russian-Russian conflict. Ukrainian.

“For India, higher reserve coverage is observed to reduce the cost of foreign borrowing as well as the cost of hedging,” said the article – Foreign Reserve Buffer in Emerging Market Economies: Drivers, motivations and implications.

It was authored by Dirghau Keshao Raut and Deepika Rawat of the Economics and Policy Research Department, RBI. The central bank said the opinions expressed in the article are those of the authors and do not represent their views.

The increase in India’s reserve reserves in recent years has been the result of modest levels of current account deficit (CAD) relative to the size of net capital inflows. This is broadly consistent with the trend seen in some emerging market economies (EMEs) in the post-Covid period, partly reflecting the impact of ultra-loose monetary policies in major advanced economies (EAs) pushing capital to out in search of higher returns, according to the article.

The country’s DAC registered a sharp decline in 2019-20 and a surplus in 2020-21. On the other hand, the capital account recorded a surplus during these two years, driven by foreign direct investment (FDI). Consequently, there was an increase in foreign exchange reserves to the tune of USD 147 billion (on a BoP basis) in 2019-20 and 2020-21. In 2021-22, the increase in reserves (including the valuation effect) was around $30 billion.

Foreign exchange reserves include foreign currency assets (which include investments in foreign government treasury bills, deposits with other central banks), gold, special drawing rights (SDRs) and position in reserve tranche (RTP).

The article indicates that there have been portfolio outflows since October 2021 due to the reversal of monetary policy stances in major emerging economies, followed by the Russian-Ukrainian conflict. This has resulted in a depletion of foreign exchange reserves in recent months.

The article further indicates that EMEs have accumulated reserves during the COVID-19 period, benefiting from abundant global liquidity propelled by ultra-accommodative monetary policies in major advanced economies.

Several EMEs recorded an increase in reserve-to-GDP ratios and reserve adequacy levels.

The report states that empirical analysis shows that over the long term, EME reserve accumulation is driven by a precautionary motive rather than a mercantilist motive.

According to the mercantilist view, reserves are accumulated to promote export-led economic growth. Under this approach, economies undervalue their currencies by using reserves to support exports.

For the precautionary purpose of holding reserves, countries maintain a reserve cushion to prevent production and consumption losses during “sudden stops” in capital flows.

The article notes that reserves help EMEs reduce exchange rate volatility, as evidenced by the negative relationship between exchange rate volatility and import reserve coverage. An increase in reserves reduces the likelihood of a currency crisis, thus implying a positive externality of holding reserves, he added.

(This story has not been edited by the Devdiscourse team and is auto-generated from a syndicated feed.)

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