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Explained: Why are commodities reserves shooting up when Indian economy is hit?

Covid-hit India’s foreign exchange reserves jumped by a record $11.9 billion in the week ending July 31 to hit a fresh high of $534.5 billion, making it the fifth largest holder of reserves in the world. During the 10-month period between September 27, 2019 and July 31, 2020, the foreign exchange reserves have swelled by $100 billion.

At a time when the economy is under stress and the growth is expected to contract in 2020-21, the rising commodities reserves have come as a breather as it can cover India’s import bill of more than one year.

India’s foreign exchange reserves: How has the rise been?

The trend of rising foreign exchange reserves started after Finance Minister Nirmala Sitharaman announced a sharp cut in corporate tax rates on September 20, 2019. While investor sentiments turned weak after the budget announcement in July to impose higher surcharge, the government’s decision to reverse its budget decision relating to higher surcharge impact on FPIs along with a cut in the corporate tax rate in September played a significant role in turning the investors mood and draw them to invest in the Indian economy and markets.

Between September 20, 2019 and July 31, 2020, the reserves have grown by $106 billion and, since the beginning of April, it has grown by $60 billion. So, in ten months India has added 25 per cent of the reserves it had till September 20, 2019. India is now fifth in global ranking behind China ($ 3,298 billion), Japan ($ 1,383 billion), Switzerland ($ 896 billion) and Russia ($ 591 billion).

What has led to this rise in commodities reserves?

The rise has been in several stages and has been led by different factors over the last ten months. Experts say that the rise in foreign exchange inflows through Foreign portfolio investment (FPI) and Foreign Direct Investment (FDI and has also been supported by decline in import bill over the last 4-5 months on account of dip in crude prices and trade impact following Covid-19 pandemic

Some of the key factors include:

FPI inflows: While it started with a sharp rise in FPI inflows following the government’s decision in September to cut corporate tax rate. Between April and December 2019, FPIs pumped in a net $15.1 billion, according to the RBI.

Dip in crude oil prices: India’s oil import bill declined as the global spread of coronavirus since February 2020 not only roiled the stock markets but also led to a crash in the Brent crude oil prices. While crude accounts for almost 20 per cent of India’s total import bill, Brent crude oil prices fell to levels of $20 per barrel towards March end, it dropped further and traded between $9 and $20 in April. In January 2020, Brent crude was trading between $60 and $70 per barrel.

Import savings: Lockdown across countries in response to Covid-19 pandemic impacted global trade and has resulted in a sharp dip in import expenditure — electronics, gold and also crude oil prices among others.

FDI inflows: Between September 2019 and March 2020 foreign direct investments stood at $23.88 billion and in April and May it amounted to $5.9 billion. Market experts say that a lot of FDI has also come in June and July too, especially the Rs 1 lakh crore plus investment by global tech giants in Jio Platforms. Thus FDI inflow has been a significant contributor to the rise in foreign exchange reserves.

Dip in gold imports: Gold which was a big import component for India witnessed a sharp decline in the quarter ended June 2020 following the high prices and the lockdown induced by the Covid-19 pandemic. According to the World Gold Council (WGC), gold imports plummeted by 95 per cent to 11.6 tonnes in the quarter as compared to 247.4 tonnes in the same period a year ago due to logistical issues and poor demand. The value of gold transacted during the June quarter fell to Rs 26,600 crore, down by 57 per cent as compared to Rs 62,420 crore a year ago, WGC said.

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