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Teji Mandi

Updated on: Thursday, October 28, 2021, 05:50 PM IST

Teji Mandi Explains: Fear of inflation looms amidst rising forex reserves

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Like people invest in various assets, the Reserve Bank of India also holds investments. It invests foreign exchange and gold reserves in several assets. The forex reserves are held in foreign currencies and are used to back liabilities. According to the recent RBI data, forex reserves have increased in the country. It’s a good thing, but the chances of rupee appreciation rise too, which is not a very good sign for us.

Recent Forex Data

The forex data is shared by the RBI weekly. It also states the options used by RBI to increase yields on this forex reserve. The week ended October 15 showed the rise in India’s forex reserves by $1.49 billion to $6.41 billion. The gold reserves also simultaneously rose by $557 million. These figures indicate India’s comfortable reserve position. But where does all this money go?

RBI’s Investment Avenues

The objective of RBI is not to make huge profits but to safeguard the reserve capital. Hence RBI invests in avenues that carry low interest rates. According to a RBI report, forex reserves parked in equity index funds can fetch higher interest rates. Since equity investment is risky, RBI believes a small portion of reserves in an index fund will augment the portfolio returns.

To give an overview, as of end-March 2021, out of the total $535 billion foreign currency assets, $359 billion was invested in securities, $153 billion with other central banks and the BIS (Bank of International Settlements) and the balance $23 billion comprised deposits with commercial banks overseas.

Rupee Appreciation Threat?

India currently has ample forex reserves, which helps keep the rupee depreciated to sustain exports. On the other hand, RBI’s motive to augment portfolio returns will only mean higher inflows, which will add pressure on the rupee again.

Depreciated currency used for exports serves the national interest, but the need for higher returns on top of the excessive forex reserves will lead to the rapid growth of money supply, which will destroy the original balance of money supply and lead to inflation.

What Should The RBI Do Then?

To ensure that the interest rates are in the target band, open market bond sales will be required to drain out the excess liquidity. That’s why the RBI generally invests in lower risk investment tools so that there’s greater external borrowing and risk-taking. This encourages the system to be tight. The central bank’s motive is to keep inflation under-control. As long as it is able to do it, RBI is doing its job.

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Published on: Thursday, October 28, 2021, 05:50 PM IST
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