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India's Foreign Exchange Reserves Key to Market Stability Amid Bond Index Inclusion

India's RBI to use $642 billion reserves for market stability amid expected bond index inflows, considering policy adjustments.

By Mackenzie Crow

5/16, 05:55 EDT
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Key Takeaway

  • India's foreign exchange reserves, nearing $642 billion, are pivotal for stabilizing the market amid bond index inclusion inflows.
  • RBI considers integrating forex intervention into its liquidity framework, a significant policy shift to manage expected $25 billion debt market inflow.
  • The central bank aims to maintain rupee stability through careful dollar buying and selling, keeping it among the least volatile emerging market currencies.

Foreign Exchange Reserves as Defense

India's foreign exchange reserves, nearing a record high of $642 billion, are set to play a crucial role in stabilizing the market against potential volatility. This comes in anticipation of increased inflows following the country's bonds' inclusion in global indexes. The Reserve Bank of India (RBI) is prepared to absorb these inflows and manage outflows effectively, maintaining market stability. The central bank may also consider adjusting its liquidity framework to include foreign exchange intervention as an official tool if large flows persist, marking a significant policy shift.

Managing Domestic Liquidity

To address domestic liquidity concerns that may arise from the bond inclusions, the RBI has several tools at its disposal, including the standing deposit facility. Additionally, the central bank is contemplating measures such as issuing market stabilization bonds, although these discussions are in preliminary stages. JPMorgan Chase & Co. and Bloomberg Index Services Ltd. are set to include India in their emerging markets bond index, potentially drawing as much as $25 billion into the country's debt market, with expectations of further index providers joining by mid-next year.

Currency Stability Amid Inflows

The RBI aims to maintain the rupee's stability despite the anticipated surge in inflows. Governor Shaktikanta Das has emphasized building foreign exchange reserves as a buffer against market selloffs. The central bank's intervention strategy involves buying excess dollars to prevent the rupee from appreciating too much and selling dollars to support the rupee during pressure. This approach has kept the Indian rupee as one of the least volatile emerging market currencies, with the RBI determined to allow the domestic exchange rate to be market-determined while preventing significant deviations from its peers.

Street Views

  • Siddharth Kothari, Sunidhi Securities & Finance Ltd. (Neutral on India's sovereign rating):

    "India’s sovereign rating upgrade could be a matter of time."

  • Badrish Kulhalli, HDFC Life Insurance Co. (Neutral on the Indian rupee and RBI intervention strategy):

    "The extent of purchases will be calibrated, as the RBI may not want to have a situation where there is undue weakness or undue strength in the rupee."