Context: India’s foreign exchange reserves crossed $500 billion for the first time.
More on news:
- The latest data from the RBI showed that India’s forex reserves surged by $8.2 billion during the week ended June 5 — the biggest weekly jump since September 2007 — to $500.02 billion.
- The increase in reserves was mainly due to a rise in foreign currency assets, which increased by $8.4 billion in the week.
- Higher reserves paradoxically lead to higher FPI (Foreign Portfolio Investors) inflows by comforting investors.
What are forex reserves?
- Forex reserves are-
- external assets in the form gold,
- SDRs (special drawing rights of the IMF) and
- foreign currency assets (capital inflows to the capital markets, FDI and external commercial borrowings) accumulated by India and controlled by the Reserve Bank of India.
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.
- According to the RBI data, as much as 64 per cent of the foreign currency reserves is held in the 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.
- Gold: 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.
- In value terms (USD), the share of gold in the total foreign exchange reserves increased from about 6.14 per cent as at end-September 2019 to about 6.40 per cent as at end-March 2020.
Significance of rising forex reserves:
- Helps in managing external and internal crisis: The rising forex reserves give a lot of comfort to the government and the Reserve Bank of India in managing India’s external and internal financial issues at a time when the economic growth is set to contract by 1.5 per cent in 2020-21.
- A big cushion: In the event of any crisis on the economic front and also are enough to cover the import bill of the country for a year.
- Helps rupee to strengthen: The rising reserves have also helped the rupee to strengthen against the dollar.
- Provide level of confidence to markets: The foreign exchange reserves to GDP ratio is around 15 per cent. 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.
- Of late, the RBI has been buying dollars from the market to shore up the forex reserves. When the RBI mops up dollars, it releases an equal amount in the rupees. This excess liquidity is sterilized through issues of bonds and securities and LAF (Liquidity Adjustment Facility) operations.
Image Source: economic times