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 of India which is used to back liabilities and influence monetary policy, chiefly comprises of
- Foreign currency assets
- Gold reserves
- SDRs (Special Drawing Rights)
- Reserve Tranche in the IMF
Need to maintain forex reserves:
- First, countries use their foreign exchange reserves to keep the value of their currencies at a fixed rate.
- To maintain liquidity in case of an economic crisis.
- To meet external obligations.
- Foreign exchange reserves are a nation’s backup funds in case of an emergency, such as a rapid devaluation of its currency.
- 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.
- The source of funding for the IMF is contribution by its Members as per their quota.
- 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.
- 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.
- 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.
- The ensuing rise in bond yields in reaction to the announcement was referred to as a taper tantrum in financial media.
- 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.