Forex Reserves

Why in news?

• India's foreign exchange (forex) reserves declined to USD 524.5 billion. Reserves are at their lowest levels since July 2020. Since last year, reserves have declined by USD 115 billion.

About Forex Reserves:

• These are assets denominated in a foreign currency that are held on reserve by a central bank. These may include foreign currencies, bonds, treasury bills and other government securities.

Components of Foreign exchange reserves:

• The Foreign exchange reserves of India consists of four categories which are:
  • Gold
  • SDRs (special drawing rights of IMF)
  • Foreign currency assets (capital inflows to the capital markets, Foreign Direct Investment and external commercial borrowings)
  • Reserve Position with IMF.
• The RBI Act, 1934 provides a legal framework for deployment of reserves in different foreign currency assets and gold within the broad parameters of currencies, instruments and issuers.

Significance of Forex Reserves:

• Comfortable Position to Government:
  • The rising forex reserves give comfort to the government and the RBI in managing India’s external and internal financial issues at a time of major contraction in economic growth.
• Managing BoP Crisis:
  • It serves as a cushion in the event of a Balance of Payment (BoP) crisis on the economic front.It is enough to cover the import bill of the country for a year.
• External Debt Obligations:
  • Assist the government in meeting its foreign exchange needs and external debt obligations.
• Strengthening of Rupee:
  • The rising reserves have helped the rupee to strengthen against the dollar.The foreign exchange reserves to GDP ratio is around 15 per cent.
• Confidence in Market:
  • Reserves will provide a level of confidence to markets and investors that a country can meet its external obligations.

Why have India’s forex reserves fallen?

• FPI outflows:
  • There has been a significant outflow of funds from the domestic market by Foreign Portfolio Investors(FPIs).To date in 2022, FPIs have withdrawn $30.3 billion from the Indian financial market.
• Rising oil prices:
  • Due to rising oil prices, the import bill goes higher, and India needs to pay more money if the price of oil is rising, which means more outflow of dollars leading to a higher trade deficit.
• FCA accounts suffer due to growing dollar strength:
  • A large part of forex reserves is by way of foreign currency assets(FCA) accounts. In FCA, the dollar, euro and pound constitute a significant part. But with the outbreak of hostilities in Eastern Europe, both the pound and euro have been sliding, which had an effect on India’s forex reserves.
• Safeguarding rupee in focus:
  • According to analysts, the major focus of the RBI has been to prop up the rupee and in doing so it ended up depleting the forex reserves to some extent.

Impact: 

• Widening Current Account deficit which is expected to stay above 3% of GDP for the current fiscal year, ending March 2023.
• Volatile Capital flows, economists expect the balance of payments to be negative, depleting reserves further.
• While reserves at current levels are adequate to cover more than eight months of imports, a further fall could start catching the market’s attention.

RBIs action:

• The RBI had announced measures to liberalise foreign exchange inflows, including giving foreign investors access to a larger portion of government debt and banks wider room to raise more deposits from non-residents.

Add ons:

• Floating sovereign bonds, like the Resurgent India bonds (RIBs) and India Millennium Deposit bonds (IMDs) may help to boost forex reserves.

PRACTICE QUESTION:

With reference to ‘foreign exchange reserves’ of India, consider the following statements:

1. They are managed by Securities and Exchange Board of India

2. Gold has the highest share in the total foreign exchange reserves of India.

Which of the statements given above is/are correct?

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

Answer