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India’s forex reserves crossed $500 billion for the first time ever

  Jul 09, 2020

India’s forex reserves crossed $500 billion for the first time ever

What are forex reserves?

Forex reserves are external assets in the form of 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. 

Why are forex reserves rising despite the slowdown in the economy?

  1. 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). 
  2. The fall in crude oil prices has brought down the oil import bill, saving precious foreign exchange. 
  3. Overseas remittances and foreign travels have fallen steeply – down 61 per cent in April from $12.87 billion. The months of May and June are expected to show further decline in dollar outflows.

What is the significance of rising forex reserves?

  1. 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. 
  2. 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. 
  3. The rising reserves have also helped the rupee to strengthen against the dollar.
  4. 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.

How much is foreign exchange reserves to GDP ratio?

Foreign exchange reserves to GDP ratio is around 15 per cent. 

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. 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 rupees. This excess liquidity is sterilised through issue of bonds and securities and LAF operations.

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 counter parties. 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. 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.

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. While the RBI has not divulged the return on forex investment, analysts say it could be around 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.