India's foreign reserves continue to march to record highs, touching USD 393 billion early this month backed by strong foreign portfolio and investment flows, according to Development Bank of Singapore.
"Strong year-to-date foreign portfolio (USD 24 billion), net investment flows (USD 13 billion) and lower absorption due to a narrower current account deficit have led to an increase in dollar liquidity," the DBS noted in its daily market report.
Notably, since late 2013's taper tantrums, the quantum of jump in India's reserves (USD 100 billion) is the highest compared to its Asian counterparts, outside of Japan, the bank said.
"If left unsterilised, these inflows will add to the rupee appreciation pressures, with the rupee already up 6 per cent so far this year, leading its BRIC (Brazil, Russia, India, China) peers," it said.
"Soaking up these dollar flows have added to the surplus rupee liquidity in the system, albeit the latter at current levels is less of a worry to the central bank's inflation mandate in midst of lacklustre credit growth," the bank said in the report.
Inferring from the central bank's intervention trends, reserves are set to rise further in the months ahead.
The authorities have been active not only on the spot but also in the forward, to minimise any immediate impact on liquidity, the DBS observed.
Accordingly, spot FX (Foreign Exchange) purchases amounted to USD 13 billion in January-June 17, while the net forward position stood at USD 16 billion, bulk of the latter in the three-month to one-year bucket.
Rising reserves build a buffer against external volatility, backed also by a narrower current account deficit, lowering India's vulnerability to external risk events, the bank said.
"However, a downside of this build-up is the associated costs and weak returns in midst of soft global yields. This was one of the reasons behind a reduction in the Reserve Bank of India surplus dividends' contribution to the government’s coffers, besides the cost burden associated with demonetisation and liquidity absorption," the bank said.