Thread by @vikas_bazaz

Yesterday, RBI reported that India's FX (forex) reserves has made a new high - $612.73 bln for the week ending July 16, 2021.

This data is issued by RBI every Friday with one week lag. One can get to see the same on the link below:

m.rbi.org.in/Scripts/BS_Pre…

India FX reserves has grown over the year and is now the world's 5th largest.

So, what is the significance of this number - FX Reserves?

FX reserves basically represent the total foreign currency holdings that RBI has. Higher the reserves, better it is for the stability of it's currency.

For any EM central bank, FX reserves works as the first line of defence against any sharp reversal in its currency, arising out of any global risk-off scenario (taper tantrum in 2013) or due to major capital outflows from India, as was seen in March 2020.

Local currency can also come under severe pressure (weakening), if trade deficit (imports > exports) continue to surge month after month and there is not enough capital flows through FPI or FDI channel to meet the shotfall.

In such cases, RBI intervenes by selling dollar from its reserves to avoid any sharp upside move in USDINR or weakening in rupee.

However, it does not mean that RBI will not allow the rupee to depreciate at all.

RBI objective is just to smoothen the volatility and not change the direction.

If global factors are not in favour and most of emerging market currencies are also weakening against dollar, RBI will also allow INR to depreciate but may be at an engineered pace.

In March 2020, when COVID led sell-off happened in all markets, INR also weakened from 72.50 to 76.90 levels, in line with other EM currencies, despite intervention (sell dollars) from RBI. Hope this clears that it is there to smoothen the volatility and not the direction.

Finally, it is also important to note that RBI can intervene from buy side as well, if it thinks INR is appreciating too fast at a time.

Just for info - in FY21, RBI maximum intervention was on buy side, as dollars inflows was just pouring in from both FPI and FDI channel. RBI bought dollar to the tune of $88 bln in FY21.

Hope this helps to understand why FX reserves are important, and central bank considers it as first line of defence.

In nutshell, RBI works as market stabilizer and this makes currency interesting. Isn't so?

Let's learn, adapt and grow.

kotaksecurities.com/investment-pro…