India’s rising forex reserves

  Aug 17, 2020

India’s rising forex reserves

Q. What is the news?

A. At a time when the economy is under stress and the growth is expected to contract in 2020-21, the rising forex reserves have come as a breather for the economy as it can cover India’s import bill of more than one year.

Covid-hit India’s foreign exchange reserves jumped by a record $11.9 billion in the week ending July 31 to hit a fresh high of $534.5 billion, making it the fifth largest holder of reserves in the world. During the 10-month period between September 27, 2019 and July 31, 2020, the foreign exchange reserves have swelled by $100 billion.

The trend of rising foreign exchange reserves started after Finance Minister announced a sharp cut in corporate tax rates on September 20, 2019. While investor sentiments turned weak after the budget announcement in July to impose higher surcharge, the government’s decision to reverse its budget decision relating to higher surcharge impact on FPIs along with a cut in the corporate tax rate in September played a significant role in turning the investors mood and draw them to invest in the Indian economy and markets.

Q. What is India’s position globally in forex reserve?

A. India is now fifth in global ranking behind China ($ 3,298 billion), Japan ($ 1,383 billion), Switzerland ($ 896 billion) and Russia ($ 591 billion).

Q. What has led to this rise in forex reserves?

A. The rise has been in several stages and has been led by different factors over the last ten months. Experts say that the rise in foreign exchange inflows through Foreign portfolio investment (FPI) and Foreign Direct Investment (FDI and has also been supported by decline in import bill over the last 4-5 months on account of dip in crude prices and trade impact following Covid-19 pandemic.

Some of the key factors include:

Q. What does the rising forex reserves mean?

Q. What does the RBI do with the forex reserves?

A. 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 issue of bonds and securities and LAF operations to prevent a rise in inflation.

Q. Are forex reserves giving returns to India?

A. Only gold reserves have given big returns to India. While the RBI has not disclosed the actual returns from forex reserves, experts estimate India is likely to get only negligible returns as interest rates in the US and Eurozone are around one per cent. On the contrary, India could be facing a cost to keep the reserves abroad. Out of the total foreign currency assets, as much as 59.7 per cent was invested in securities abroad, 33.37 per cent was deposited with other central banks of other countries and the BIS and the balance 7.06 per cent comprised deposits with commercial banks overseas as of March 2020. Further, as at end-March, 2020, the RBI held 653.01 tonnes of gold, 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. With gold prices shooting up around 40 per cent, the value of gold holdings has shot up.