India's Falling Foreign Exchange Buffer Triggers Calls for More Flexible Currency Management

Indian Rupee Weakness Weighs on Foreign Exchange Reserves

The Reserve Bank of India's (RBI) efforts to defend the rupee are taking a toll on the country's foreign exchange reserves, leading to concerns about the nation's ability to manage its currency. As of the latest data, India's foreign exchange assets, excluding gold, cover only 8.7 months of imports, the lowest level in three years.

This decline in reserves is partly due to the RBI's increased intervention in the currency market to shield the rupee, which has been hovering near its record low of 92.4788 per dollar. In the week of March 6, foreign exchange assets fell to $563 billion, down from a peak of $591 billion in June. Overall reserves, supported by higher gold prices, declined by the most since November 2024.

Some analysts, including Indranil Pan, chief economist at Yes Bank Ltd, believe that the RBI should be more flexible in its approach to rupee depreciation. Pan notes that the exchange rate is the only shock absorber in the external sector and that the RBI needs to allow for rupee depreciation to some extent.

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India requires a foreign exchange reserve buffer of at least $1 trillion to ensure robust intervention capacity, according to Michael Patra, former RBI deputy governor. The RBI's ammunition to support the rupee is lower after accounting for outstanding dollar sales, with its forward book at $67.8 billion at the end of January.

Dhiraj Nim, FX strategist at Australia and New Zealand Banking Group, suggests that the RBI can let the rupee adjust a bit more before the level of reserves becomes a concern. However, defending a particular level of the rupee could become problematic if the fundamentals have shifted for good.