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Content

• Basics
• Why Foreign Exchange Reserves are important?
• How much Foreign Reserve do we have?
• Some Recent Steps by RBI

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Basics

Composition of India’s foreign Exchange Reserves and who manages these reserves?

India’s foreign exchange reserves comprise.

• Foreign currency assets (US$, Euro, Pound, and Yen): It is expressed in US Dollar or Indian rupee terms.
• Gold reserves of RBI: The RBI has gold stocks as a backup to issue currency and to meet
  unexpected balance of payment problems.
• Reserve Tranche:
  • It consist of India’s quota (member subscription fee) to IMF and lending to the General Resource of IMF.
    • Note: The General Resource Account is the pool of member countries’
      quota payment.
  • Special Drawing Rights (SDR) holdings of the government
• Managed by RBI.
  • RBI Act and Foreign Exchange Management Act, 1999 set up the legal provisions for governing the foreign exchange reserves.
  • The RBI functions as the custodian and manager of forex reserves and operates within the overall policy framework agreed upon with the Centre. It allocates the dollars for specific purposes.
    • For e.g., under the Liberalized Remittances Scheme, individuals are allowed to remit up to $2,50,000 every year.
  • The Central bank uses its forex kitty for orderly movement of the rupee. It sells the dollar when the rupee weakens and buys dollar when the rupee strengthens.

Why Foreign Exchange Reserves are important?

• It acts a cushion against domestic currency volatility once the global exchange rate start rising.
•  It increases the confidence in the monetary and exchange rate policies of the government.
• During balance of Payment crisis foreign exchange reserve come to the rescue of any country so as to absorb the distress related to such crisis.
• Strong forex reserves also helps a country to adopt more aggressive countercyclical measures and emerge from a short-lived recession.
• It also adds to the comfort of market participants that domestic currency is backed by external assets and hence it also helps the equity markets of the country, because due to strong reserves many people from foreign countries are willing to invest in the country.

However, holding too much foreign exchange reserves is also not advisable -> (Opportunity Cost)

How much Foreign Reserve do we have?

• India’s forex reserve at $602 billion as of Aug 2023: RBI
  • Foreign Currency Assets (FCAs): $534.40 billion
  • Gold Reserves: $44.34 billion
  • SDR: $18.32 billion
• Note: India’s foreign reserve had peaked in Sep 2021 at $642.45 billion.

How did India’s foreign exchange reserves increase till Sep 2021? (Not by exports; but by import of capital)

Why the recent drop in the reserves?

• Largely due to steps taken by the Reserve Bank of India to support the rupee.
• Increasing trade deficits (and Current Account Deficits)
• Capital outflow (FIIs have pulled out) [given the rising global interest rates and bond yields on the back of monetary policy tightening by the US Fed and other major central banks.

Some Recent Steps by RBI:

• In July 2022, RBI has announced a series of measures including relaxation in:

i. Foreign investment in debt:

• • FPIs in government securities and corporate debt made till 31st Oct 2022, will be exempted from this short-term limit. These will not be reckoned for the short term limit of one year till maturity or sale of such investments.

ii. External Commercial Borrowings

• • Increase the limit under automatic route for ECBs from $750 million or its
    equivalent per financial year to $1.5 billion.

iii. NRI Deposits:

• RBI has allowed banks temporarily to raise Fresh Foreign Currency Non-Resident Bank i.e., (FCNR (B)) and Non-Resident External (NRE) deposits without reference to the current regulations on interest rates. This relaxation is available till 31st Oct 2022.
• From July 30, 2022, incremental FCNR(B) and NRE deposits with reference base date of 1st July 2022, will be exempt from the maintenance of CRR and SLR.

Conclusion:

• With reserve bank of India showing willingness to use reserves to defend the rupee – ensuring “orderly evolution” of the exchange rate with “zero tolerance for volatile and bumpy movements” – a further drawdown of foreign exchange reserve is possible. The forex reserve was, after all, accumulated as a buffer against currency volatility, external shocks and sudden stop in capital flows. As RBI Governor Shaktinath Das has recently put it, “You buy an umbrella to use it when it rains”.

Example Question:

• Why is forex reserve crucial for any economy? Discuss the key factors behind decreasing forex reserve in India over the last few months [15 marks, 250 words]