November 24, 2022
  • November 24, 2022

Measures to boost foreign exchange inflows are welcome

By on July 10, 2022 0


Measures to boost foreign exchange inflows are welcome

Demand for foreign currency, mainly the dollar, has increased due to increased imports and rising commodity prices

The Reserve Bank of India was expected to take action to boost currency flows into the country given the continued weakness of the rupee, so last week’s package came as no surprise. The measures aim to support the rupee, whose weakness poses many challenges, including a negative impact on inflation. The demand for foreign currencies, mainly the dollar, has increased due to increased imports and rising commodity prices. Exports have not increased proportionately. The country’s trade deficit increased in June and the current account deficit is expected to exceed 3% of GDP this year. There is an increasing outflow of capital for various reasons. Foreign portfolio investors have been steadily selling their holdings since the start of the year. This is mainly due to interest rate hikes in the United States and the tendency to minimize risk in times of global uncertainty.

The package consists of three measures that aim to increase dollar supplies. Banks have been incentivized to source more NRI deposits by removing the requirement to maintain additional reserves for additional deposits over the next four months. They were given the freedom to set the interest rates for these deposits without being constrained by the existing restrictions. Although an increase in foreign currency deposits is welcome, it is not certain that banks have enough incentive to take this risk in a deteriorating environment. Second, the rules have been relaxed for Foreign Portfolio Investments (REITs) in the Indian debt market. But the possibility of further rupee depreciation and high inflation, which would drive interest rates negative, could make REITs unattractive in the near future. The third measure of the package is the easing of the conditions to be met by Indian companies to borrow abroad. Whether companies will be willing to borrow in foreign currency in an uncertain financial and economic environment and when interest rates rise overseas remains to be seen.

Although there are questions against each of these measures, even limited gains can prove useful. Although the current position of foreign exchange reserves at $593 billion is not cause for concern, a combination of capital flight, currency depreciation and inflation can pose serious challenges, particularly as India is a net importer of raw materials. A larger foreign exchange reserve will help cushion the impact better. Some elements indicate that the situation may not worsen much more than today. Commodity prices have started to show some moderation and the current REIT exit may reverse if the US enters a recession. It’s premature to predict the impact of the package, but it can provide a shield if things get worse.

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