How did India lose $100 billion?
India’s foreign exchange market includes banks, corporate entities and foreign institutional investors. The average daily turnover hovers around $60 billion. In 1993, India moved to a market-determined rate of exchange mechanism.
In 1999, the Foreign Exchange Management Act was passed under which the Reserve Bank of India (RBI) facilitates “external trade and payment and promotes orderly development and maintenance of foreign exchange market in India.”
Over the past 29 years, the Indian rupee’s (INR) rate of exchange against foreign currencies was largely determined by market forces of demand and supply but the RBI has a history of intervening apparently to maintain ‘orderly conditions’ and ‘curb excessive volatility’.
A year ago the Reserve Bank of India (RBI), India’s central bank, had a hefty $642 billion in foreign exchange reserves. RBI’s foreign exchange reserves have now dropped to $545 billion. How did RBI manage to lose a colossal $97 billion?
In September 2021, a United States dollar was worth Rs74.25. By 16 December 2021, the rupee had fallen to Rs76.21, a devaluation of around 3 percent.
Reportedly, RBI sold billions of dollars out of its reserves in the foreign exchange market in order to stabilize the rupee. By January 2022, RBI’s efforts had borne some fruit and the rupee regained some of its lost value. For the record, RBI’s efforts proved short-lived and by March 2022 the rupee had fallen to Rs77 to-a-dollar.
Reportedly, the RBI intervened once again, selling billions of dollars out of its reserves. RBI’s efforts once again were successful but once again short-lived. By July 2022, the rupee once again fell to Rs80 to-a-dollar. The RBI came back into action spending several billions out of its reserve to defend the falling rupee.
The RBI defended the rupee well bringing it down to Rs78.6 to-a-dollar. Once again the RBIs intervention proved successful but for a mere four weeks as the rupee fell once again to Rs80 to-a-dollar by end-August.
By end-September 2022 the rupee had fallen to Rs81.6 to-a-dollar, a year-over-year devaluation of 10 percent.
Over the same period-September 21 to September 22-the RBI ended up losing a colossal $97 billion defending the rupee-and yet failed. The RBI, having lost a hundred billion dollars in a year, is now desperately looking to replenish its reserves.
Question: Why has the Indian rupee been falling? Answer: India’s “current account deficit is likely to touch $105 billion or 3 percent of the GDP this fiscal, mainly due to the continuously widening trade deficit (according to Bank of America).” A current account deficit is an indication of an unbalanced economy.
A current account deficit is an indication of an uncompetitive economy. A current account deficit always risks currency depreciation. The RBI unwisely stepped in to defend the falling rupee just when the current account deficit was touching a hundred billion dollars. The RBI failed. Cost of the failure: $100 billion.
In 1991, the United Kingdom’s current account deficit had hit $19 billion. In 1992, the UK’s current account deficit swelled to $23 billion. In 1992, the Bank of England, the United Kingdom’s central bank, decided to fight the market forces of demand and supply in an attempt to defend the falling pound.
September 16, 1992, “known as Black Wednesday, was the day speculators forced the British government to pull the pound from the European Exchange Rate Mechanism”. Back then the “UK Treasury estimated the cost of Black Wednesday at Pound 3.3 billion.” The Bank of England lost billions trying to defend the pound-but failed.
The lesson from these multi-billion dollar central bank failed ventures-both by the Reserve Bank of India and the Bank of England-is that there is no central bank on the face of the planet that has the resources to defeat market forces-and defend a falling currency. The real lesson here is: Market forces eventually prevail.