Forex reserves of India

2021 OCT 20

Preliminary   > Economic Development   >   Indian Economy and Issues   >   External sector

Why in news?

  • RBI report on ‘The low yield environment and Forex Reserves management’ stated that investment of India’s rising foreign exchange reserves in equity funds can fetch higher returns as interest rates which have been on a declining trajectory over the last four decades in advanced economies, have touched their historic lows.

What are forex reserves?

  • Forex reserves or foreign exchange reserves are external assets accumulated by India and controlled by the Reserve Bank of India
  • Total forex reserves of India were USD 639.51 billion as on October 8, 2021. This fourth largest in the world (Below China, Japan and Switzerland).
  • India’s foreign exchange reserves to GDP ratio is around 15 per cent
  • The Foreign exchange reserves of India consists of below four categories;
    • Foreign Currency Assets
    • Gold
    • Special Drawing Rights (SDRs)
    • Reserve Tranche Position

Purpose of holding forex reserves:

  • The International Monetary Fund says official foreign exchange reserves are held in support of a range of objectives like supporting and maintaining confidence in the policies for monetary and exchange rate management including the capacity to intervene in support of the national or union currency.
  • It will also limit external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed.

Why are forex reserves rising in India?

  • The major reason for the rise in forex reserves is the rise in investment in foreign portfolio investors in Indian stocks and foreign direct investments (FDIs).
  • On the other hand, the fall in crude oil prices has brought down the oil import bill, saving precious foreign exchange.

What’s the significance of rising forex reserves?

History of India’s forex reserve:

In 1980, India had foreign exchange reserves of over USD 7 billion, more than double the level (USD2.55 billion) of what China had at that time

In 1990, forex reserve covered just 4.8 weeks of imports. Therefore its followed by Economic reforms of 90s, that is LPG policy.

In 2020, India for the first time crossed the 500 Billion USD mark.

  • It’s a big cushion in the event of any crisis on the economic front and enough to cover the import bill of the country for a year
  • The rising reserves have also helped the rupee to strengthen against the dollar.
  • Reserves will provide a level of confidence to markets that a country can meet its external obligations, demonstrate the backing of domestic currency by external assets, assist the government in meeting its foreign exchange needs and external debt obligations and maintain a reserve for national disasters or emergencies.

What does the RBI do with the forex reserves?

  • The Reserve Bank functions as the custodian and manager of forex reserves, and operates within the overall policy framework agreed upon with the government.
  • The RBI allocates the dollars for specific purposes.
  • For example, under the Liberalised Remittances Scheme, individuals are allowed to remit up to $250,000 every year.
  • The RBI uses its forex kitty for the orderly movement of the rupee. It sells the dollar when the rupee weakens and buys the dollar when the rupee strengthens.

Where are India’s forex reserves kept?

  • The RBI Act, 1934 provides the overarching legal framework for deployment of reserves in different foreign currency assets and gold within the broad parameters of currencies, instruments, issuers and counterparties.
  • As much as 64 per cent of the foreign currency reserves are held in securities like Treasury bills of foreign countries, mainly the US, 28 per cent is deposited in foreign central banks and 7.4 per cent is also deposited in commercial banks abroad, according to the RBI data.
  • India also held 653.01 tonnes of gold as of March 2020, with 360.71 tonnes being held overseas in safe custody with the Bank of England and the Bank for International Settlements, while the remaining gold is held domestically.
  • The share of gold in the total foreign exchange reserves is 6 percent as of March 2020.

Is there a cost involved in maintaining forex reserves?

  • The return on India’s forex reserves kept in foreign central banks and commercial banks is negligible
  • Return on forex investment is only one per cent, or even less than that, considering the fall in interest rates in the US and Euro zone.
  • There was a demand from some quarters that forex reserves should be used for infrastructure development in the country. However, the RBI had opposed the plan.
  • Several analysts argue for giving greater weightage to return on forex assets than on liquidity thus reducing net costs if any, of holding 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