USHoliday,revrepoauctionsandFXreserves

Asian markets are trading in a mixed range as Hang Seng and Shanghai are in green whereas Nikkei is trading down. The US Stock futures are also in red in the Asian trade. The US markets will remain closed today on account of Martin Luther King, Jr. Day. A downbeat US retail sales data on Friday where it dropped 0.7% for the month of December and doubts on whether the 1.9 trillion USD Biden stimulus package will have a safe passage through the congress are weighing on the equity prices resulting in Dow Jones ending Friday down by 180 points.

On the domestic front though, there were some important newsworthy events which have happened since Friday. First one was the results of the 2-lac crore INR variable rate reverse repo auction. The cut off at 3.55 was weaker than expected and resulted in a further sell off in bonds. We have seen that since the time the announcement to conduct the rev repo auction was done the yields especially in the shorter end segment have moved up significantly. The 10-year benchmark bond yield is trading at 5.98 currently against 5.89 seen on the 8^th of January.

The other important event on the domestic circuit was a speech delivered by RBI Governor on Saturday the 16^th of January titled as “Towards a Stable Financial System”. The full text of the speech is available on the RBI website. In his address, the governor touches on various initiatives which the RBI has taken to strengthen the financial system in respect of policies and oversight mechanisms. He recalls the learning from the GFC where he highlights that individual entities were well capitalised, but the individual strength didn’t add up to systemic stability.

The most relevant portion in his speech from an FX market perspective were his comments on the stability of the external sector. He outlined that a weak external sector can pose a threat to domestic financial stability as happened during the GFC (2008) and the taper tantrum (2013). He says that the EMEs like India in order to mitigate the global spill over effects have no choice but to build their forex reserve buffers. This should be done even at the cost of being included in the currency manipulators list or some other monitoring lists. However, he commented that the Indian reserve position remains adequate in terms of conventional metrics like “cover for imports” and “reserve to short term debt”. The WSS released on Friday indicated that the overall FX reserves for India now stand at 586-bn USD for the week ending 8^th of January.

We have in past discussed that the addition to reserves has a cost attached to it and also gave our readers some historical context while discussing the contours of East Asian contagion crisis. As per some academic literature the East Asian crisis in the late 90s marked the first instance when the issue of hot money was deeply debated and building FX reserves came out as one of the important lessons from it. As the real economies of many countries were damaged by sudden exodus of foreign money, the fickle nature of this kind of flows has been a central theme of many debates since then.