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.
Reason for Rising of Forex (Foreign Exchange):
- Increase in Foreign Currency Assets.
- The surge in the Gold Reserves.
- Increased Special drawing rights (SDR) with the International Monetary Fund (IMF).
- Increased reserve position (Reserve Tranche Position) of India with the IMF.
Foreign Currency Assets:
- It is expressed in US dollar terms.
- It includes the effect of appreciation or depreciation of non-US units like the euro, pound, and yen held in the foreign exchange reserves.
- They are assets held on reserve by RBI in foreign currencies.
- These reserves are used to back liabilities and influence monetary policy.
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.
- Usually, RBI modifies classical sterilization by including fiscal policy measures in order to overcome problems like inflation.
- RBI’s Stand on Sterilization: It intervenes in the foreign exchange market to curb volatility and does not target a particular level of the exchange rate.
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 for a few months.
- Net foreign direct investment (FDI) rose to $20.9 billion in the first half of 2019-20 from $17 billion a year ago.
- Net foreign portfolio investment (FPI) was $8.8 billion in April-November 2019 as against net outflows of $14.9 billion in the same period last year.
- 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.
Higher forex reserves are a must for India. It is due to India has higher imports and lower export earnings.
Also read: India’s Big Foreign Policy Shake-Up