Lauren Miller

May 16, 2024 - 06:25 am

India Bolsters Defenses with $642 Billion Reserve Amid Global Index Inclusion

As India braces for an upsurge in capital inflows following the anticipated inclusion of its bonds in global indexes, the Reserve Bank of India (RBI) is preparing its nearly record-high $642 billion in foreign exchange reserves to keep market gyrations in check.

India's Forex Strategy in Response to Index Inclusion

The Reserve Bank of India, the nation's central banking authority, is primed to fortify the economy against potential market instabilities through strategic use of its vast foreign exchange reserves. This move materializes as a precaution against the projected increase in capital inflows prompted by India's inclusion in prominent global bond indexes.

The central bank has articulated its approach, detailing plans to equilibrate the capital surges with parallel outflows utilizing the near-record high reserves — to the tune of approximately $642 billion. The anonymity of the sources referencing the central bank's private discussions is maintained for confidentiality. This tacit strategy underscores the RBI's efforts to mitigate any direct impacts from the forthcoming bond index inclusions that aren't immediately concerning. However, the central bank remains vigilant, considering potential adjustments to its liquidity framework. This would incorporate foreign exchange interventions as an official policy instrument in instances where large and persistent flows demand it, marking a distinct shift from the current policy that aims solely to temper volatility.

Liquidity Management Tactics

In managing India's domestic liquidity, the RBI is poised to employ various instruments at its disposal, highlighting the standing deposit facility as a pivotal measure. This strategy includes pondering about additional interventions, like encouraging the government to release market stabilization securities. Some of these proposed actions are in the preliminary discussion phase and might not materialize.

Implications of Emerging Market Bond Indexes

JPMorgan Chase & Co. is slated to bring India into the folds of its emerging markets bond index come June. The financial giant approximates that this could channel as much as $25 billion into India's debt arena. This is punctuated by Bloomberg Index Services Ltd.'s plan to integrate India into its own emerging markets index starting January 2024. Being part of the more extensive Bloomberg LP conglomerate, Bloomberg Index Services manages a suite of indexes that offer competitive alternatives to those from other index administrators.

On the horizon, the RBI anticipates at least one more index curator joining the bandwagon by mid-2024, with FTSE Russell already considering India for its emerging market bond index.

Sovereign Credit and the Inflow Expectation

The central bank also envisions India's sovereign credit standing to receive an elevation on the back of the bond index admissions. This enhancement is likely to attract even more foreign capital. Currently, rating firms like Moody’s Ratings and Fitch Ratings Ltd. position India on the border of the investment-grade threshold. An upgrade would cement investor confidence and magnify capital inflows.

RBI’s Resolve for Currency Stability Amid Inflows

The RBI's commitment to the stability of the rupee in a landscape marked by increasing inflows, coupled with the potential for swift outflows, remains unflinching. The central bank maintains a stance that, despite its robust interventionism, desires for a domestic exchange rate that truly reflects the market. There's a fine balance as the officials acknowledge the potential strengthening of the rupee but vow not to let it deviate too radically from its counterparts.

For context, the Indian rupee has outperformed its emerging Asian peers this year, depreciating by a mere 0.4% in contrast to steeper slides in currencies like the Indonesian rupiah and Korean won.