Question

Sources of foreign exchange reserves under portfolio investment

Answer 1

Total foreign exchange (FX) reserves touched $360 billion as of 1 April 2016, compared to the February end stock of $347 billion. In March, nearly $11 billion was added to foreign currency assets, which jumped to $336 billion. The remarkable fact is that despite such a whopping accretion in reserves, or alternatively, surplus FX purchases, net of external financing, the rupee still strengthened more than 3% during the month. At the end of March, the rupee-dollar was at Rs.66.30-66.20 compared with the February end value of about Rs.68.
What explains this huge increase in FX reserves? Considering the steady decline of FX assets—$1.2 billion each in January and February 2016, a steeper $2.4 billion fall in November 2015 and a small $159 million increase in December, what underlies this remarkable turnaround? How has the position swung so sharply?
Foreign portfolio investments, a major source on the capital account side, were net surplus at $2.9 billion in March. Not much is known about the other components. For example, foreign direct investment has been strong, but the amount will be known with a lag. A strong influx of remittances, a current account item, could have bolstered reserves too, but this too will be known after a while. Further, the possibility of the current account turning surplus cannot be entirely disregarded. Seasonally, the gap narrows in the last quarter of the financial year. And February’s merchandise trade deficit, the difference between exports-imports—the main current account component— was down to $6.5 billion from $7.6 billion in January. In comparison, the October-December 2015 quarter saw a monthly average trade deficit of $11.3 billion.
There were also reports of heavy selling by speculators in the first week of March when long positions built up ahead of the budget in the domestic forward and futures, as well as in the offshore, non-deliverable forward market, were unwound in post-budgetary relief. Excess dollars flooding the market, therefore, would have been scooped up by the RBI. Nonetheless, this happened after accommodating a fair bit of rupee strengthening. The rupee-dollar rate reached Rs.66.5 by the third week of the month (March 21). The last week of March, which saw a $3.5 billion weekly rise in FX assets, resulted in some more appreciation.
Another possibility is forward intervention operations of the Reserve Bank of India (RBI) as past forward purchases matured. The central bank’s outstanding forward position was -$2.4 billion (net sales) in February, and it has been a net seller in the spot market since December last year. Forward intervention operations are difficult to identify as the data are known with a two-month lag, while maturities are cast into ranges of 1-month, 3-months, 12-months and so forth. Still, the latest maturity profile of RBI’s outstanding forward purchases in the one-month bucket was $2.4 billion in February, $400 million less than the previous month’s position.
Assuming these were fully bought in March; that adds $2 billion to the net foreign portfolio investment inflow for the month, leaving approximately $6-7 billion of excess inflow to be explained.
More information is needed to figure this out. Meanwhile, the outstanding forward position as per the RBI’s maturity breakdown disclosure shows net forward sales beyond three months. As the seasonality in the current account balance disappears in the April-June quarter, will the overall FX position then reverse.
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