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COVID-19 and India's Monetary Response

The world turned upside down with the COVID-19 spreading to its zenith. Like many countries, India paused all the economic activities due to the rapid growth of active cases in the economy. To boost the miserable sectors and industries, the government and RBI are undertaking accommodative policies and measures to revive the financial markets and banks. While India announced the first lockdown in the third week of March, the economy had penetrated effects of the COVID on the financial sector and other firms. With China and other countries closing borders, the international trade and movement of people halted. Though India officially secured the country in the later March, the external sector had got severely affected, with multiple foreign investments withdrawn from the economy.

India has a history of increasing current account deficits because of incessant imports except in a few years. Current Account Deficits (CAD) tells the value of an economy’s imported and exported goods and services. However, the CAD has narrowed down from 2.7 per cent to 0.2 per cent of the GDP in the third quarter of the FY 2019-20 thanks to the oil price decline, lowering imports demand and net service receipts in the economy. According to the data from RBI, the contraction in CAD resulted from reduced trade deficit at $ 34.6 billion and net service receipts at $ 21.9 billion. On the other hand, forex reserves increased to $473 billion and became the seventh-largest reserve pool globally, which acts as a contingent cushion to outlive the global uncertainties. Apart from the rise in foreign currency assets and depreciation adjustments, the forex reserves elevated because of FDIs and FPIs in the previous year. With the robust built-up forex reserves and plummeted CAD, India entered the COVID world. Nevertheless, the country experienced a few premature effects in the investment sector.

The rampant spread of COVID spooked the entire financial markets. The currencies of emerging market economies suffered from downside pressures as the investors dumped a variety of assets in their flight to safety. In this process, the demand for US dollars rose across the markets as the investors scurried off to hedge upon safe assets. Moreover, the foreign investors’ sale of domestic securities amounting to Rs 23237 crores led the rupee to remain in an aggravated position for weeks in March. To that, RBI decided to open the US Dollar/INR swap window of $ 2 billion for six months to meet the soaring demand of greenback. Through this swap, RBI sold dollars to the needy banks in return for rupees, which have seen a huge drain of dollars. Hence, the swap increases the dollar availability in the market as the FPIs were excessively buying dollars. Consequent to the acute sale of $12 billion worth FIIs and equity sell-offs, the rupee further depreciated to 75.20 against the dollars being the highest decline in that quarter.

With rising forex reserves and dropped CAD, on one hand, RBI had weakening rupee to concern about. For which, RBI undertook frequent purchase and sale of dollars to even the forex reserves and, to prevent the rupee from a further fall (beyond 77 against the dollars). The table below shows the change in the amount of forex reserves.

Source: CNBC TV

In the third week of February, RBI began its initial sale of around $ 0.49 billion to withhold the rupee’s fall between 70.5 to 72.50 levels, which is the usual one year range. By February-end and early March, RBI purchased a total of $ 9.68 billion even when the rupee traded above 72. On March 13 and 20, when rupee went beyond 75.20, RBI sold a bulk of $ 14 billion to bring it below 74.50 level and then a purchase of $2.56 billion to close the rupee at 74.80. Similarly, in April, RBI initiated three transactions amounting to $ 2.22 billion to level up the rupee adjustments. RBI at times continued buying dollars even with depreciation as the oil prices were declining and compared to other emerging market currencies, the rupee was performing pretty well. Furthermore, it aided in inducing the liquidity in the market. Besides this, RBI released a quantum of money in tranches to banks in the LTRO and TLTRO window to make them invest in NBFCs as a means to avail the liquid funds effectively in the economy.

With forex reserves adequate to cover up for the next ten months’ imports, RBI and the central government came up with new schemes to regain the lost FPIs and FDIs. FPIs have been net sellers in debt markets since 2019 though the investment limit doubled, and with this pandemic, the flight to safety and dumping assets spree was a matter of concern, as this eroded a part of the county’s investments and reserves. The Voluntary Retention Route revised the time limit to six months, which lured a considerable portion of the Portfolio Investments in May compared to the previous month which withdrew nearly 1 lakh crores. Experts said that the sharp fall in net outflows could be because of the containment measures undertaken by India. Following this, the net FPI inflows stabilized to $ 3.5 billion by June. Moreover, the lump sum of 97000 crores to Reliance and Jio platforms from global tech giants in June and July multiplied the forex reserves. The graph as per the data available till July 31 depicts the steep increase in the Forex reserves.

Source: Indian Express

The main reason for the continuous rise in forex reserves in that quarter was due to the expansion in the FPIs, FDIs, foreign currencies and reduced import bills. As a result, RBI’s Balance Sheet is exploding from the beginning of the implementation of COVID-19 policies with accretion to Rs 9.5 lakh crores since mid-February. Majority of the balance sheet accumulation consisted of 50 per cent of forex reserves, 30 per cent through LTROs and 20 per cent by the purchase of domestic securities.

Questions are arising for what exactly could be done with the massive balance sheet size of the RBI but, the surplus needs to be analyzed before transferring to the government. RBI declared the dividends for the year 2019-20 (July-June), which would come in the government receipts of 2020-21. The government anticipated Rs 60,000 crores as dividend while the actual dividend was Rs 57128 crores. RBI constituted the Bimal Jalan Committee to design the Economic Capital Framework which requires the RBI to maintain Realised Equity from the surplus balance sheet as Contingency Risk Buffer between the ranges 5.5 to 6.5 per cent. Normally, the panel is not supposed to provide the interim dividend to the centre except under exceptional circumstances, which RBI has not paid for the year ended June 2020. Last year, RBI transferred an amount more than the expected dividend to the government, which helped them to rein in the fiscal deficit. So, for FY19-20, RBI decided to fix at 5.5 per cent for the contingency buffer and transferred the Rs. 57128 crores to the centre. Though it is not what has been expected by the Government with a huge criticism on the government’s reliance on RBI, the dividend would support the economy in this financial strained situation. Hence, the surplus transfer would be used to control fiscal deficits which are 83.2 per cent (as on June 30) of the budget target of Rs 7.96 trillion.


Financial Express

Economic Times


The Indian Express

by Bharathi Jayaraman (


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