Falling reserves and the bogey of the RBI’s role

Source: The post is based on an article “Falling reserves and the bogey of the RBI’s role” published in The Hindu on 14^th October 2022.

Syllabus: GS 3 – Economic Development

Relevance: concerns associated with the declining forex reserves and the role of the RBI

News: There is a widespread misconception that the Reserve Bank of India (RBI) has been depleting India’s foreign exchange (forex) reserves to defend the rupee.

As per reports, India’s forex reserves have reduced from $642 billion to $537 billion from September 8, 2021 to September 30, 2022 due to selling of dollars in India’s inter-bank forex market. However, this could be a misconception.

How RBI Controls the forex market?

It is well established that that the RBI has a role in determining dollar/rupee rate.

The players in the forex market are the banks licensed by the RBI and the RBI itself.

Individuals and corporates cannot enter the forex market. They can deal only with their respective banks. So, the RBI dominates the forex market as the regulator, a player and the jury.

Further, the forex market is regulated by the RBI with the exchange control regulations and all the banks are required to hold a fix forex reserves at the close of business hours each day.

Why RBI’s intervention cannot deplete forex reserves?

RBI’s Interventions are not sufficient to deplete forex reserves due to few reasons:

First, even if RBI sells a certain amount of dollars in the market. It is not going to deplete automatically. The amount will be reduced if the sold dollars are purchased by some bank and bank then remit these dollars to a licensed importer.

Second, if a purchasing bank start to speculate, then also forex reserve may deplete. But it is not permitted by the RBI.

Third, selling these dollars in the overseas cross currency market are also prohibited by the central bank.

Therefore, until and unless there is a demand of dollars from an authorized bank customer, reserves cannot go out.