Is RBI targeting $500 billion forex hoard?

India's forex reserves hit a record high at $327.88 billion for the week ended January 30, recording a sharp climb of $5.85 billion in a week, according to the Reserve Bank of India (RBI).

The central bank is forced to increase its war chest of forex reserves as the European Union opens up a huge quantitative easing even as interest rate hike by the US Federal Reserve seems imminent. 

The move is to prevent potential chaos in the market in case the foreign portfolio investors, especially in debt segments, retreat when the interest rates in US start to climb, expected sometime in the second half of 2015.
Market participants say that the RBI governor Raghuram Rajan may be targeting a forex reserves to $500 billion. 

Reserves surpassed a previous high by touching $322.13 billion reported on January 23. The previous all-time high of $320 billion reported in September 2011.

Earlier this week, the central bank had said there was accretion to the country's foreign exchange reserves to the tune of $6.8 billion in third quarter of this fiscal.

The $60 billion-a-month quantitative easing by ECB will lead to inflows into India, pushing the rupee up. The RBI needs to buy dollars to keep a runaway rupee in check as it could hurt imports. 

The quantitative easing and prolonged concern over slowdown in China have added to the financial market volatility across emerging markets, which will force RBI to build up its reserves, according to experts. 

Rajan has often said that there is no comfort at any level of the forex reserves, and market participants say that the governor is bullish to build up reserves to prepare for any unforeseen market volatility.

In a post-policy analyst conference call on Wednesday, Rajan said, “...I think the hope that a number of central bankers have is that they are building a bridge to the future and that they walk off the bridge fairly easily because the deep ravine or chasm is bridged. My fear has always been that the bridge stops halfway and we have to exit it at a time that we have not reached the other side, and then we know that there is a deep fall... So we just have to prepare for volatility...”

Bank of America Merrill Lynch said in a report, “Against this backdrop, we continue to expect governor Rajan to continue to recoup forex reserves to fight possible contagion when the Fed raises rates in September (as our US economists expect). Besides spot purchases, it has bought $39 billion in forwards since April. If it consistently buys forex, our BoP forecasts that the RBI can reach 10 months' import cover by March 2016, well above the critical eight-month import cover needed for rupee stability.

Ashutosh Khajuria, president - treasury, Federal Bank, said, “RBI wants to build a war chest to prevent a mayhem in the market when the foreign portfolio investments specially in the debt segments flow out once the interest rates in US start to climb.”

Pranjul Bhandari, chief economist, HSBC Securities & Capital Markets, said, "What perhaps needs managing though is the rising surplus on the overall balance of payments. A shrinking CAD (current account deficit) and improving growth prospects in India should keep capital coming in at a healthy pace. This has already resulted in the rupee appreciating against its trade partners, and that too despite RBI mopping up foreign currency to build its armour of reserves. We expect the RBI to continue shoring up reserves, given it is still some way off from pre-2008 levels of six months of import cover."