RBI Waves Caution Flag: Volatile Capital Flows Now Cover Three-Fourths of Forex Reserves

The Reserve Bank of India (RBI) registered a significant improvement in the foreign exchange reserve-covered ratio of volatile capital flows as of end-December 2024, indicative of increased external sector vulnerability during this time. This is also in the face of volatile world capital flows and changing external debt dynamics. Recent data highlight the need to remain vigilant about the external stability of India as the short-term borrowing and portfolio inflows increase proportionally relative to the forex cover of the country.

 

Key Points

 

Volatile Capital Flows to Reserves: Steep Rise

 

The proportion of volatile capital flows (portfolio inflows and short-term outstanding debt) to foreign exchange reserves increased to 74.3% as of December end 2024, compared to 67.8% as of September end 2024.

 

This is a notable rise in external vulnerability, with a higher ratio reflecting a larger proportion of the reserves being at risk of having potentially swift outflows.

 

Short-Term Debt to Reserves: Ongoing Increase

 

The short-term external debt-to-reserve ratio also increased as of the end of December 2024.

 

Previous data indicated this ratio stood at 20.3% as of June 2024, indicating a rising trend of short-term obligations in comparison to forex reserves.

 

An elevated short-term debt ratio can magnify risks if financial conditions in the world tighten abruptly.

 

Foreign Exchange Reserves: Still Strong, But Tapering

 

India's foreign exchange reserves totaled about USD 640.3 billion as of December-end 2024, enough to finance 10.9 months of imports and nearly 90% of external debt.

 

Reserves had risen to a level of over USD 704 billion as of September 2024 before easing, implying some depletion or valuation effects in the second half of the year.

 

Import Cover and External Debt Dynamics

 

The cover provided by reserves continues to be above 10 months, a level widely regarded as sufficient to protect against external shocks.

 

Despite this, the increasing proportion of short-term debt and volatile capital flows in the mix of external liabilities warrants continued caution.

 

Broader Context: Global and Domestic Implications

 

The rise in volatile capital flows could be an indication of both global risk sentiment as well as domestic market conditions, including short-term borrowing and portfolio investment patterns.

 

The RBI report points towards prudent management of reserves and continued evaluation of the resilience of India's external sector.

 

Sources: Press Information Bureau, AffairsCloud, Economic Times, Times of India