India’s foreign exchange reserves have experienced a significant decline, falling by $8.7 billion to $625.9 billion for the week ending January 10, 2025. This marks the sixth consecutive week of reduction, bringing the reserves to their lowest level in ten months.

Breakdown of Reserves

The Reserve Bank of India’s (RBI) data indicates that the primary component of this decline is a $9.5 billion decrease in foreign currency assets. Conversely, the value of gold reserves saw an uptick of $792 million during the same period.

Factors Contributing to the Decline

The substantial reduction in forex reserves is largely attributed to the RBI’s active intervention in the foreign exchange market. These interventions aim to mitigate the depreciation of the Indian rupee, which has been under consistent pressure over the past few months. Since October 1, 2024, the rupee has depreciated by 3.2%, reflecting the challenges posed by a strengthening U.S. dollar and fluctuating capital flows.

Rupee’s Performance

The Indian rupee continued its downward trajectory, declining by 6 paise against the U.S. dollar on January 17, 2025, closing at 86.61 per dollar. Over the week, the rupee registered a 0.74% depreciation against the greenback.

Global Context and Central Bank Actions

India’s situation is reflective of a broader trend among emerging market economies. Central banks in these regions have been offloading U.S. Treasury bonds to support their weakening currencies. This strategy has contributed to a decline in U.S. Treasury ‘custody’ holdings, reaching their lowest point since April 2020. Such actions have intensified the bond market’s volatility, creating a cycle where rising yields bolster the dollar, prompting further interventions from foreign central banks.

RBI’s Strategic Approach

In response to these challenges, the RBI has indicated a more judicious use of its foreign exchange reserves to address domestic currency market volatility. The central bank plans to intervene as necessary to smooth out market fluctuations but aims to avoid excessive measures that defend specific currency levels. This approach underscores the RBI’s commitment to ensuring that the rupee’s valuation aligns with India’s economic fundamentals.

Economic Implications

The continuous decline in forex reserves has several implications for India’s economy:

• Import Costs: A weaker rupee can lead to higher import costs, particularly for essential commodities like crude oil, thereby exerting upward pressure on domestic inflation.
• Investor Confidence: Sustained depletion of forex reserves may affect investor sentiment, potentially leading to capital outflows and increased volatility in financial markets.
• Policy Flexibility: Diminishing reserves could limit the RBI’s capacity to intervene in the forex market, constraining its ability to manage currency stability effectively.

Outlook

As global economic conditions remain uncertain, the RBI’s measured approach to utilizing its forex reserves will be crucial in maintaining financial stability. Market participants and policymakers will need to monitor these developments closely to navigate the challenges posed by external pressures and ensure the resilience of India’s economy.