Home Forex Exchange Where did the dollars to India’s forex reserves come from in FY20? – Livemint

Where did the dollars to India’s forex reserves come from in FY20? – Livemint

5 min read

MUMBAI: India’s foreign exchange reserves at half a trillion dollars sound formidable and markets have drawn a lot of comfort from this. Among emerging market peers India fares better than most on the pile of forex reserves. But how the reserves are built is a key factor to watch for. After all, the source of dollars determines how volatile or stable funds are.

Unlike other countries such as Thailand or even China where reserves are driven by current account surpluses, India’s reserves are mainly through its capital account. In FY20, the capital account surplus swelled thanks to a rise in foreign direct investment (FDI). For India, FDI forms the biggest source of accretion of reserves. To that extent, there is comfort as FDI not only shows confidence in long-term economic growth narrative but is also a stable source of dollars. In FY20, FDI contributed $43.1 billion towards reserves or 66% of total reserve accretion during the year. FDI comes in handy during periods of sharp volatility in global markets that tend to destabilise portfolio flows into the country.

While this is a good part, there is also trouble hidden in forex reserves. About 35% of reserve accretion during FY20 was from external commercial borrowings. These are loans taken by private sector companies that eventually need to be paid back. Commercial borrowings form a sizeable portion of the additions to forex reserves every year. This is borrowed money. In fact, commercial borrowings are also behind the increase in the country’s external debt.

In FY20, foreign exchange reserves swelled by $59 billion as against a small drain of $3.3 billion the previous year.

Since then, reserves have grown more to reach the record $500 billion level.

Besides import cover, two other ratios that determine whether forex reserves of the country are enough are the cover they provide for total external debt and more importantly short-term debt.

Short-term debt is debt maturing within the next one year. As of end FY20, the ratio of short-term debt to forex reserves was 49.5%, a sharp drop from 57% in FY19. What this means is if India had to repay all its debt maturing in FY21, it would require about half of its forex reserves to do so. The improvement in the ratio is driven by not just the rise in forex reserves but also a drop in debt levels. Considering the impact the coronavirus pandemic has had on trade, short-term debt is expected to drop further in FY21.

In the ratio of reserves to total debt, we run into a bit of trouble. Foreign exchange reserves cover 85% of India’s total external debt in FY20. Improvement in this ratio depends on how much the private sector ends up borrowing from overseas. Total external debt grew by 2.8% in the last fiscal year led by 6.7% growth in external commercial borrowings. Private sector entities have been borrowing more every year from overseas owing to low interest rates. It is unlikely that this trend would change in the current year as well. Ergo, this ratio has the potential to weaken marginally this year.

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