India's forex reserves climbed to a record high as dollar inflows surged following recent measures by the central bank to attract capital into the country. The Reserve Bank of India's (RBI) forex reserves gained $12.4 billion to reach an all-time high of $729.3 billion in the week of August 21, according to data released by the central bank on Friday. This surpasses the previous record of $728.5 billion set in February.

Key Highlights

• India's forex reserves hit a record $729.3 billion, up $12.4 billion, surpassing February's previous high.
• RBI's special deposit programme garnered $72.8 billion in inflows, with carry cost estimated at $5.7 billion annually.

RBI's Special Deposit Programme Draws $72.8 Billion in Inflows

Steps taken by the RBI in early June, including a special deposit programme for overseas citizens, have garnered $72.8 billion in inflows through August 21. This has helped avert what could have been an unprecedented third consecutive year of deficit in India's broadest measure of money flowing in and out of the economy.

The boost to forex reserves has given the central bank greater firepower to support the rupee, which remains one of Asia's worst-performing currencies. The unit has recovered around 1.7% from a record low hit in May, but continues to face pressure from elevated oil prices, given India's heavy dependence on fuel imports.

Dollar Inflows Come at a High Cost for the RBI

While the dollar inflows cushion India's external position, attracting them has come at a significant cost, as the RBI is bearing banks' hedging expenses under the diaspora deposit scheme, enabling lenders to offer attractive interest rates to overseas customers.

This has become costlier for the central bank now, given that US interest rates stand at much higher levels than they did in 2013, the last time the RBI turned to overseas residents for similar deposits.

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Dhananjay Sinha, Head of Research at Systematix Shares and Stocks Ltd, wrote in a note that the mobilisation under the ongoing RBI swap scheme highlights the acute limitations of relying on expensive, debt-funded reserve mobilisation to stabilise the rupee. He noted that the central bank typically deploys dollars in assets whose returns are substantially lower than the expense incurred in raising money under the special programme, adding that the "carry cost" for the country could amount to around $5.7 billion annually.

Earlier this month, the RBI unexpectedly brought forward the closure of the diaspora deposit programme, with Governor Sanjay Malhotra noting that inflows had been stronger than expected.