RBI rebuilding reserves to prevent downgrade to junk

India is using a surge in inflows into local bonds and equities to rebuild its currency reserves, boosting its ability to avoid a junk debt rating.

The Reserve Bank of India bought $820 million more than it sold in March, the first net purchase since 2010, official data published May 13 show. The RBI has purchased $1 billion since then and will buy an additional $8 billion through March 2014, Bank of America Merrill Lynch estimated in a May 16 report. The promise of the highest returns in Asia has boosted overseas holdings of Indian debt 15 percent this year to an all-time high of $37.8 billion, according to data compiled by Bloomberg.

RBI Governor Duvvuri Subbarao said this month India should be prepared for the probability of outflows next year as developed economies consider withdrawing stimulus measures. Even so, Standard Chartered Plc recommends investors buy the rupee to profit from a 4 percent gain by the end of this year as foreigners load up on debt after the government reduced taxes on the investments.

“Given India’s foreign-exchange reserve adequacy has worsened considerably, the central bank will use capital inflows to rebuild its reserves,” said Priyanka Kishore, a strategist at Standard Chartered in Mumbai. “The RBI is likely to let the rupee strengthen once it is more comfortable with the current-account outlook.”

The rupee is little changed in 2013 after slumping 22 percent in the past two years as inflation overshot the central bank’s target and the current-account deficit widened to a record. The currency stabilized after Prime Minister Manmohan Singh’s government further opened Asia’s third-largest economy to foreign investors and price pressures eased.

Bloomberg

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