India’s foreign exchange reserves rose by USD 1.51 billion to USD 658.09 billion on a weekly basis on November 29. That’s eight straight weeks of declines from an all-time high of $704.89 billion reached on Sept. 27 (see chart).
Not only has foreign exchange reserves declined by $46.79 billion in the nearly two months since September 27, but the rupee has also weakened from 83.67 to 84.66 against the US dollar. September 27 was also when the BSE Sensex and the NIFTY 50 benchmark stock market indices touched a peak of 85,978.25 and 26,277.35 points respectively.
The period following those highs has been marked by foreign portfolio investors (FPIs) pulling money out of India’s equity and debt markets. Their net sales were $11.47 billion in October alone and another $2.54 billion in November. As these outflows – basically dollars leaving the country – put pressure on the rupee, the Reserve Bank of India (RBI) had to support the domestic currency. It did so by selling dollars from the official foreign exchange chest. This, in turn, has led to a depletion of its sole custody reserves.
Sources of foreign exchange reserve movements
A decrease or increase in foreign exchange reserves, however, is not the only reason why FPIs withdraw or bring money into the Indian market.
Reserve movements are a function of a country’s balance of external payments (BoP) transactions, both current and capital. Current account transactions basically include exports and imports, goods and services.
India has traditionally been more of an importer than an exporter when it comes to trade in goods. In 2023-24, its merchandise exports, at $441.48 billion, were much lower than imports, at $683.55 billion, translating into a deficit of $242.07 billion. The accompanying table shows the annual trade deficit running from $102.15 billion in 2020-21 to $265.29 billion in 2022-23.
In services it’s the other way around – what’s called an “invisible” account. This account has consistently posted surpluses, doubling from $98.03 billion in 2016-17 to $218.78 billion in 2023-24. This has mainly been courtesy of two major invisible receipts items: exports of software services and remittances from Indians living abroad.
Net software exports increased from $60.96 billion in 2011-12 to $70.76 billion in 2016-17 and $142.07 billion in 2023-24. Much of this was in the wake of the Covid pandemic, which spurred the digitization of business and government functions globally and spurred the export of information technology services from India.
Along with software, net exports of “business” and “financial” services increased to $29.24 billion and $3.49 billion in 2023 from $(-)361 million and $(-)424 million respectively in 2020-21. 24. This is likely due to multinational corporations setting up global competence centers in India, providing specialized solutions – from research and development to accounting and customer support – to their parent offices and subsidiaries around the world.
Private remittance transfers – dollars, dirhams, euros and pounds sent home by the Indian diaspora – fell from $63.47 billion in 2011-12 to $56.57 billion in 2016-17, from $101.78 billion in 2022-23 and $101.78 billion in the previous year. $1326 billion in 2022-23. .
Current Account Relief
The net effect of the widening of the invisible surplus along with the widening trade deficit has been to reduce the imbalance in India’s overall external current account.
The current account deficit (CAD), which had reached $78.16 billion in 2011-12 and $88.16 billion in 2012-13, narrowed to $23.29 billion in 2023-24. There are years like 2021-21, when the current account has also turned positive.
In fact, India is one of the few countries with a much lower CAD than its merchandise trade deficit. China had a goods trade surplus of $593.90 billion in 2023, with exports of $3,179.19 billion and imports of $2,585.30 billion. But it also, unlike India, had an invisible deficit of $340.91 billion, reducing its total current account surplus to $252.99 billion.
A strong and structurally surplus invisible account—mainly thanks to exports of software services and remittances from overseas Indians—has kept India’s CAD at a manageable level. It also reduced the impact of a structurally high goods trade deficit, possibly reflecting the growing loss of competitiveness of the country’s manufacturing and tangible production (as opposed to services) sectors.
Capital account risk
India’s BoP problems today mainly stem from capital, and not the current account.
As long as CADs are modest, they can be financed through capital inflows. Over the years, net capital inflows have actually exceeded CAD, with additions by the RBI and additions to official foreign exchange reserves. Recent years have seen more increases and decreases in only a few, such as 2011-12, 2018-19 and 2022-23. Outstandings with the RBI have increased from $294.40 billion in 2011-12 to $646.42 billion in 2023-24, and a further $658.09 billion by November 29, 2024.
Capital inflows include foreign direct investment (FDI), FPIs, external commercial borrowing (ECB) and non-resident Indian (NRI) deposits.
Among these, FDI flows are considered more stable, as they usually involve long-term investment in factories and physical assets, which boost the country’s productive capacity and job creation. The other three sources are either volatile (FPI) or short-term (ECB and NRI deposits), while prone to sudden outflows and withdrawals (foreign banks can also quickly repay or recover loans from borrowers at uncertain times).
According to the RBI’s BoP data, FDI inflows into India fell from $42.01 billion in 2019-20 to $56.01 billion in 2019-20, $54.93 billion in 2020-21 and $56.23 billion in 2021-22 and $26.47 billion in the following two fiscal years. Net FPI inflows, by contrast, hit a record $44.08 billion in 2023-24.
The current pressure on the rupee from the capital account is different from the situation in 2011-12 and 2012-13. That was the time when there was a big CAD in India too. The drying up of capital flows – triggered by the US Federal Reserve’s decision to gradually unwind (“taper”) its bond buying program (read dollar printing) – made matters worse, sending the rupee into free fall amid dwindling foreign exchange reserves. .
This time, things don’t look so bad, despite stable FDI and volatile FDI inflows, as well as uncertainty from another Donald Trump US administration. CAD is not as high as it used to be and in the worst case can be financed by some drawdown of reserves.