Forex reserves pile-up may not keep pace

The sharpest weekly jump in India’s foreign exchange reserves may be a one off event as future pace of increases may not be as sharp despite some easing of pressure on the rupee due to softening crude and commodity prices and a less hawkish Fed.

China is re-emerging as a competitor for international investors’ funds. As China begins to ease curbs and move to focus on the economy, it’s beaten down valuations vis a vis India’s steepest valuations could turn out to be India’s disadvantage and temper down flows.

The country allocation, considering a 12-month window, has tilted significantly in favour of China (+12 percentage points (ppt) vs October) and South Korea (+15ppt vs October) at the expense of India (-13ppt vs October) and Taiwan (-11ppt vs October), according to Bank of America Securities' latest Fund manager survey. " The Asia FMS supports a tactically constructive view on China with key concerns being addressed by credible policy actions last week" said Ritesh Samadhiya and Aritra Baksi, equity strategists at BofA Securities in a BofA Global Research report.

As a result, foreign exchange inflows may continue amidst relatively better fundamentals among emerging market peers, but may not keep pace with the latest week. " We think India’s fundamentals and attractiveness on growth remains high " said Rahul Bajoria, chief India economist at Barclay's Capital. " But some re-circulating away in tactical inflows cannot be discounted".

India's foreign exchange reserves rose record $14.7 billion to $544.72 billion in the week ending November 11. But are still down from around $630 billion at the beginning of this year as the RBI sold a portion of the reserves to prevent a sharp fall in the rupee this year.

71% of participants in the BofA Securities survey expect easier monetary policy in China in the coming year. This could imply an conducive economic policy for economic growth in China, hence making the Chinese equities more attractive.

An imminent global slowdown too could impact foreign currency flows into the economy. " As risks of a global slowdown increase, the pace of exports is likely to slow down (with demand getting dented) and imports should moderate as well (given the fall in commodity prices and exports) ,'' said Upasna Bharadwaj, chief economist at Kotak Mahindra Bank. The net impact would be a wider trade deficit and a higher dollar demand to meet merchandise trade commitment.

Besides, overall financial conditions in India are expected to tighten further with rising market interest rates and a weakening rupee, according to a report by ratings firm Crisil. This could impact the pace of portfolio flows to India.

But a revival of investments could still keep the forex flowing through other routes such as external commercial borrowings, foreign direct investments and even NRI deposits. As for NRI deposits, future flows would depend on the magnitude of expected slowdown in advanced economies as well as the pace and timing of further interest rate actions, the Reserve Bank economists said in their latest assessment of the Indian economy, published in its latest monthly bulletin.