Iran war: Forex reserves fall by USD 30 bn; will it increase India’s challenges?

India’s foreign exchange reserves have seen a steep decline following the tensions in the Middle East over the past month. In just three weeks, forex reserves have dropped by USD 30 billion. This sharp fall has raised concerns. The question now is whether the decline will stop here or continue further. Is the fall in forex reserves a cause for worry?

Professor Seema Sharma from the Department of Management Studies at IIT Delhi told The Federal that the sharp rise in crude oil prices has significantly increased India’s import bill, putting pressure on foreign exchange reserves. In addition, the Reserve Bank of India (RBI) has been intervening by selling dollars to prevent a fall in the rupee. She added that the ongoing sell-off by foreign investors in the Indian stock market amid the Iran war is worsening the scenario.

Also read: Rupee at 95, Sensex in a spiral: Is India bracing for 2008-kind meltdown?

Professor Sharma said the crisis in the Middle East must end at the earliest, otherwise the situation could deteriorate further and pose a serious threat to not only India but also the global economy as a whole. “The entire world needs to come together to end this crisis. Geopolitical conflicts should not be resolved at the cost of global economic stability. Employment for people is far more important than brutal methods of ending conflicts.”

Surge in crude oil prices adds to troubles

The ongoing conflict over the past month involving the US, Israel, and Iran has triggered a sharp spike in crude oil prices. In just one month, prices have surged by over 50 per cent. Before the conflict began, crude oil was trading at around USD 70 per barrel; it is now close to USD 115 per barrel.

This has made crude oil imports significantly more expensive for government oil companies, which now have to pay much higher prices than before the conflict. Their challenges do not end there. Since the escalation of tensions, the rupee has also weakened sharply against the dollar, falling to around 95 per dollar.

Also read: US burns USD 10,300 a second in Iran war, says SIPRI study

This has resulted in a double blow for India’s public sector oil companies. With crude oil becoming costlier and the rupee weakening while the dollar strengthens, these companies now require more dollars to import crude oil, contributing to the depletion of forex reserves.

Forex reserves fall by USD 30 billion in 3 weeks

At the start of the Iran conflict, India’s forex reserves stood at USD 728 billion, with foreign currency assets accounting for USD 573 billion. However, within three weeks, reserves declined sharply to USD 698 billion, while foreign currency assets fell to USD 559 billion. In other words, reserves dropped by USD 30 billion in just three weeks.

According to a report by foreign brokerage firm Bernstein, the concerning aspect is the currency component of the reserves—Foreign Currency Assets (FCA)—which has now fallen to $555 billion, below 2021 levels. The share of FCA in forex reserves has been steadily declining and is currently below 78 per cent, compared to over 90 per cent in 2021.

While the surge in gold prices partly explains this shift, the actual value of FCA is about 10 per cent lower than in September 2024, which is a matter of concern.

RBI’s strict measures prove ineffective

The report noted that India recorded a current account surplus in the fourth quarter over the past two financial years, largely due to service exports and strong remittances. However, the situation appears different this time. The merchandise trade deficit could turn adverse for India, and remittances—accounting for nearly 40 per cent of total inflows—may weaken due to the Middle East situation.

The report suggests that the fourth quarter may slip back into deficit. When global conditions are highly unfavourable and foreign institutional investors continue to pull out funds rapidly, the RBI’s intervention tends to have limited impact. This was evident on Monday, March 30.

To curb speculation in the currency market and arrest the sharp fall, the RBI took a major step on March 28 by capping banks’ Net Open Rupee Position (NOP) at USD 100 million. Earlier, banks were allowed to hold dollars up to 25 per cent of their capital, which had increased the scope for speculation. Despite this move, the rupee continued to slide, touching a historic low of 95.23 against the dollar.

Finance minister says forex reserves remain strong

Addressing concerns over the rupee’s depreciation in the Lok Sabha, Union Finance Minister Nirmala Sitharaman said India’s economy remains strong and its financial position is sound. She noted that the government has kept the fiscal deficit under control over the past five years, earning global appreciation. India’s forex reserves, she said, remain intact and robust.

When will the conflict end?

Economic and banking expert Ashwani Rana told The Federal that although forex reserves have declined, there is no need for alarm. He said further sharp declines are unlikely from here. As soon as conditions normalise, foreign portfolio investors are expected to return and crude oil prices may ease, which would help rebuild forex reserves.

However, any improvement will depend on how quickly tensions in the Middle East subside and how soon foreign investors return to Indian markets.

(This article was originally published in The Federal Desh)