Why is it in the news ?

India's Forex reserves crossed the $450-billion mark for the first time ever on the back of strong inflows.

  • It enabled the central bank to buy dollars from the market which enabled it to check any sharp appreciation of the rupee.

Significance of the rise in foreign exchange reserves

  • It will give the RBI the firepower to act against any sharp depreciation of the rupee.
  • It will give reserve impetus to the Indian Economy as it can be equated with the Imports to India (Linked with Import Cover) for a few months.


Forex Reserves

Forex reserves of India which is used to back liabilities and influence monetary policy, chiefly  comprises of

  1. Foreign currency assets
  2. Gold reserves
  3. SDRs (Special Drawing Rights)
  4. Reserve Tranche in the IMF

Need to maintain forex reserves:

  1. First, countries use their foreign exchange reserves to keep the value of their currencies at a fixed rate.
  2. To maintain liquidity in case of an economic crisis.
  3. To meet external obligations.
  4. Foreign exchange reserves are a nation’s backup funds in case of an emergency, such as a rapid devaluation of its currency.
  5. Foreign-exchange reserves act as the first line of defense for India in case of economic slowdown.


Special Drawing Rights

  • The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves.
  • The SDR is neither a currency nor a claim on the IMF.
  • The value of the SDR is based on a basket of five currencies—the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling.

Reserve Tranche

  1. The source of funding for the IMF is contribution by its Members as per their quota.
  2. A part of the contribution is treated as an Emergency account which is called Reserve Tranche, which a country is free to withdraw without any service fee or any external conditions.

Sterilization by the RBI

  • Sterilization is a monetary action used by RBI in order to stem the negative effects emerging from capital inflows or outflows from a country's economy.
  • Classical sterilization involves RBI conducting buy and sell operations in open markets (OMO- Open Market Operations).
  • Usually, RBI modifies classical sterilization by including fiscal policy measures in order to overcome problems like inflation.

Taper Tantrums

  1. The phrase, taper tantrum, describes the 2013 surge in U.S. Treasury yields, resulting from the Federal Reserve's (Fed) announcement of future tapering of its policy of quantitative easing.
  2. The Fed announced that it would be reducing the pace of its purchases of Treasury bonds, to reduce the amount of money it was feeding into the economy.
  3. The ensuing rise in bond yields in reaction to the announcement was referred to as a taper tantrum in financial media.
  4. This prospective policy of reducing the rate of Fed asset purchases represented a massive negative shock to investor expectations, as the Fed had become one of the world's biggest buyers.