Rising foreign inflows made the rupee one of the best performing currencies this year vs the US dollar.
India's foreign exchange reserves
today stands at an all-time high of $393 billion, driven by rising foreign inflows into domestic markets. And it could hit the $400 billion milestone next month, says a report from global financial services major Morgan Stanley. Rising foreign direct investments also helped in accretion of foreign exchange reserves. According to Morgan Stanley, the pace of India's foreign exchange reserve accretion has been the strongest since 2015 and the gain in India's foreign reserves has been one of the strongest within the Asia ex-Japan region in the past 12 months.
"Foreign direct and institutional flows remain robust, tracking at $63 billion (2.7% of GDP) and $17 billion (0.7% of GDP) on a 12-month trailing sum basis," Morgan Stanley said. "As of 4 August, forex reserves hit an all-time high of $393 billion. If the pace of forex reserves is similar to that of the past four weeks, forex reserves would hit $400 billion by September 8, 2017."
Indeed, if one is to consider the forward positions, India's foreign exchange reserves are already at $407 billion, Morgan Stanley said. Forward position refers to a contract in the foreign exchange market that locks in the exchange rate for the purchase or sale of a currency on a future date. Forward positions in the currency market are used as a hedging strategy.
However, rising capital inflows and weak credit offtake has presented some challenges to Reserve Bank of India in terms of excess liquidity in the financial system. "As capital flows remain buoyant, this puts appreciation pressures on the currency and could lead to excess liquidity, which would create challenges for the RBI to manage its monetary policy," the report said.
According to a recent Reuters report, the RBI will likely have to drain up to $22 billion in excess liquidity
from the financial system as surging foreign investments forces the central bank to absorb the dollar inflows and sell rupees to cap gains in the local currency.
Rising foreign inflows have made the rupee one of the best performing currencies this year against the US dollar, rising around 6 per cent. The rupee earlier this month hit a 2-year high of 63.58 against the US dollar. The rupee's sharp rise however is hurting exporters, says industry body Assocham.