The surge of global liquidity added by global central banks have led to strong inflows into emerging economies like India.

So far this year, foreign portfolio flows alone have brought in a net of Rs 80,783 crore, according to data available on the National Securities Depository Ltd. One-off foreign direct investment flows have also come in this year.

In order to prevent sudden appreciation in the rupee, which in the past has led to disruptive corrections, the RBI has absorbed a large chunk of forex inflows. Since April 3, foreign exchange reserves have risen from $475.6 billion to $579 billion now.

The purchase of these forex flows in turn have added to the liquidity surplus in the domestic market, prompting analysts to question whether the RBI should permit more appreciation in the rupee.

The U.S. Treasury department’s decision to put India back on the currency manipulator’s watchlist could keep RBI somewhat “guarded on aggressive forex intervention”, said Madhavi Arora, economist at Emkay Global.

We note that the forex accretion has been the main mode of unsterilised primary liquidity injection this year. A slightly toned-down stance on forex (intervention) could be positive for the rupee at the margin. Ceteris Paribus, government securities may also gain marginally with a consequential higher possibility of open market operations as mode of liquidity injection.

Why is India back in the Monitoring List again?

India, which has for several years maintained a “significant” bilateral goods trade surplus with the US, crossed the $20 billion mark, according to the latest report. Bilateral goods trade surplus totalled $22 billion in the first four quarters through June 2020.

Based on the central bank’s intervention data, India’s net purchases of foreign exchange accelerated notably in the second half of 2019. Following sales during the initial onset of the pandemic, India sustained net purchases for much of the first half of 2020, which pushed net purchases of foreign exchange to $64 billion–or 2.4% of GDP–over the four quarters through June 2020.

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