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Economy

Forex Reserves at the Highest Ever, but RBI Controls Balance Sheet to Restrict Inflation

The RBI’s back to buying dollars by the truckload. Forex reserves have been going up substantially.

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The RBI has over $322 bn of cash reserves, and then another $13 billion from forwards (it may even be higher since the forward exposure number is from November).

This is the highest ever forex reserve we have ever held.

The RBI has not just bought in the spot market this (financial) year, it’s bought a truckload in the forward market as well, totally over $66 billion:

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Offset by Sales in Govt Bonds, Inflation Stays on Hold

And the difference this time is that the RBI has managed to do this without stoking inflation. With every purchase of dollars, the RBI has sold government bonds. To buy dollars they have to print rupees which could introduce inflation. But when they sell government bonds, they get rupees back, which takes them out of circulation.

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The red shaded areas are when RBI let its balance sheet grow insanely. In the 2009 to 2013 zone, they bought both Forex and Government bonds, expanding money supply very rapidly.

It’s only since Sep 2013 that our balance sheet has seen a slower growth because of the simultaneous bond sales and forex purchases. (Currently the balance sheet has grown at 4% per year). A low balance sheet growth controls inflation.

This is the brilliance of the RBI this time. Although I don’t like the fact that they accumulate forex reserves instead of making the rupee free, this is the second best approach to forex management.

The large amount of dollar buying probably coincides with massive foreign investor interest in January. Interestingly the interest in bonds is so high that the RBI’s bond sales are also not causing any damange to the bond market.

The monetary battle in the world markets just heated up with the Euro and Yen fighting to reach the bottom; the Ruble and Chinese Yuan are getting to be free. The next battle isn’t going to be one of forex reserves, it will be the rise of the emerging currencies. In that battle, forex reserves might actually be an impediment.

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  • esotericBlue says:

    1. would chinese free yuan?
    2. would russians free ruble?

  • What really bothers Rajan would be the plight of dollars when Fed hikes rates, that is the reason he is buying in Forward markets as well to ensure stability to Rupee when that happens. He fears that the mad rush to convert into dollars will crush emerging economy currencies. But I think situation is not that worse though RBI is preparing for worst case. All in all, forex reserves would top out this year and next year on wards we are likely to see them tapering off and Rupee gaining.

  • Balance sheet expansion during 2010-2013 was insane and it was done mostly to finance Govt. expenditures. Sonia and then finance minister Pranab were responsible for this.
    Controlling Balance sheet is needed until real GDP growth sees further improvement. Hopefully Rajan makes the system tamper-proof before he leaves RBI.