As of 4 October, India had foreign exchange reserves of $701.2 billion, a slight dip from late September, as the Reserve Bank of India (RBI) sold some dollars to steady the rupee, but almost $54.8 billion more than at the start of 2024-25.
Our memory of a 1991 forex crunch (and the Asian Crisis of 1997) may have turned a swelling stash into an index of security on the external front, but a shadow cast by global geopolitics today calls for a shift in lens.
Sure, large foreign assets assure us money to pay for imports, offer a capital buffer against outflows, arm RBI with what it needs for currency stability, and bolster investor confidence in the country’s solvency, making foreign funds cheaper to access.
Since reserves are mostly invested in low-yield bonds like US Treasuries, their returns are meagre, but forex adequacy also spells policy autonomy as loans need not be sought from multilateral lenders.
Yet, ever since the US and its allies froze $300 billion of Russia’s holdings in 2022, forex reserves have willy-nilly been on the world’s radar as a geopolitical target. And now with America’s disposition subject to further flux as the globe splits into rival blocs again, RBI has new kinds of scenario planning to do.
In the analysis of economist Barry Eichengreen, forex strategies have either a ‘Mercury’ or ‘Mars’ orientation. A Mercurian strategy has foreign currencies held in a ratio that satisfies trade (and other payment needs), but the world has been tilting towards a Martian game, under which holdings follow a geopolitical calculus.
Wisely, RBI does not disclose the break-up of its reserves by currency. While both Mercurial and Martian logic would ordain a bulky share of US dollars for us, the central bank must plan for what a potential Donald Trump presidency in the US might imply.
Not only would globalization suffer a setback, with his threat of reciprocal tariffs a particular pain-point, he has warned against attempts to ‘de-dollarize’ trade. What’s more, he wants to make US imports dearer and exports more competitive by means of a weaker dollar.
This would mainly be aimed at China, possibly with US money deployed to buy its yuan, but such actions could trigger a currency war whose fallout could impact all exchange rates. This may include the rupee’s, even if it is not a direct target (given our modest trade surplus with America).
A problem, though, would arise if the US clubs India with China to label our forex upswell as a sign of ‘currency manipulation.’ It has happened before.
RBI’s stance has long been clear. It intervenes in the currency market not to peg the rupee at any level, but to calm its volatility. To the extent our dollar accretion reflects investment flows and remittances more than export earnings, it does not distort trade and thus isn’t unfair to others.
Moreover, RBI has an inflation target. Since capital is free to move in and out (through major channels), it can defend a peg only at the cost of domestic price stability.
Buying dollars floods the system with rupees; unless RBI anyway needs to ease its monetary policy, extra liquidity is inflationary if it isn’t mopped up with bond sales.
While this trade-off between the rupee’s external and internal stability does grant RBI some space for operational flexibility, it constrains its ability to deploy a cheap rupee as a trade ploy.
The slide of our currency, now under ₹84 to the dollar, has been gentle. Should it still end up as a target, RBI will need to act. It’ll need to shield exports from an inflated rupee without letting inflation slip out of control.
