Recently, the Reserve Bank of India (RBI) witnessed a significant shift in its foreign exchange transactions, reaching its lowest in almost two months. Indian foreign exchange reserves dropped to approximately $527.78 billion as of August 18, 2023.
According to data from The Reserve Bank of India, released on Friday, this was their most vital weekly decrease in over half a year. After being the net buyer of US dollars for three consecutive years, the RBI turned into the net seller, selling USD in spot markets, where financial instruments, such as commodities, currencies, and securities are traded.
What Are Foreign Exchange Reserves?
Simply put, foreign exchange reserves are funds in foreign currencies kept aside by a central bank. These funds consist of government bonds, treasury bills, and other globally accepted financial tools. The main reasons for holding these reserves is to provide a safety net during economic downturns and to help stabilise or affect a country's currency value.
Why and How Did the RBI Turn into a Net Seller in FY23?
The RBI intervenes in the foreign exchange market primarily to stabilize the value of the rupee. The central bank's buying or selling of dollars affects its profits, which in turn influences the dividend given to the government.
The RBI sold dollars to offset rupee depreciation due to the Ukraine-Russia conflict and US interest rate increases.
The rupee fell by around 5% over the last year in 2022, but the RBI's actions stopped it from declining further.
From August 1, 2022, when the rupee was at about 78, it weakened to nearly 83 by August 15, 2023. During this period, the RBI began selling its US dollar assets to stabilize the rupee. As a result of these interventions, the rupee has slightly strengthened to 82.61 as of August 28, 2023.
(Source: TradingView) Chart A
Chart: B
The charts clearly illustrate the RBI's strategy of stabilizing the rupee. By releasing its foreign dollar reserves into the market, it increases the dollar's supply, reducing its demand. This, in turn, helps in bolstering the rupee's value.
Let's observe the chart and understand:
On September 16, 2022, the RBI sold foreign currency assets worth $4,698 million in the spot market. This led to a reduction in reserves from $506,994 to $ 484,901 million as depicted in Chart B. Consequently, the rupee's value improved, settling at 79.84 against the dollar, as depicted in Chart A.
On March 10, 2023, the RBI released $2,224 million from its dollar reserves into the market. This action led to a decrease in its Foreign Currency Assets (FCA) from $496,441 million to $494,863 million, as shown in chart B. As a result, the rupee appreciated, moving from 82.53 to 82.01 against the dollar, as illustrated in chart A.
Conclusion:
Stabilizing the Rupee is of paramount importance to maintain India's economic health. It requires a multifaceted approach that includes prudent monetary policies, strategic trade decisions, and fostering a conducive environment for foreign investments. With these measures in place, the Rupee can maintain its stability, fostering growth and prosperity for the nation, the RBI's dollar sales in FY23 resulted in significant profits, leading to a higher dividend payout to the government.