News Highlight
India’s foreign exchange reserves fell to the $560 billion mark in the week ending September 2.
Key Takeaway
- In August month, the reserves witnessed a sharp decline as RBI leaned toward taming the rupee depreciation against the US dollar.
The foreign exchange reserves
- These are assets held on reserve by a central bank (RBI) in foreign currencies, which can include bonds, treasury bills, and other government securities.
Objectives behind holding forex reserves:
- Help monetary policy:
- Supporting and maintaining confidence in the policies for monetary and exchange rate management.
- Provide economic security:
- Provides the capacity to intervene in support of the national or union currency.
- Limites external pressure:
- Limits external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed.
India’s forex reserves include
- Foreign Currency Assets (FCA):
- FCAs are assets that are valued based on a currency other than the country’s own currency.
- FCA is the largest component of the forex reserve. It is expressed in dollar terms.
- The FCAs include the effect of appreciation or depreciation of non-US units like the euro, pound, and yen held in the foreign exchange reserves.
- Gold reserves:
- Gold occupies a special position in the foreign reserves of central banks as it is widely stated to be held for reasons of diversification.
- Moreover, the unique property of gold is believed to be its ability to enhance the credibility of the central bank when it holds adequately. This has been proven time and again.
- Gold compares extremely favourably to other traditional reserve assets with high quality and liquidity, helping central banks preserve capital, diversify portfolios, and mitigate risks in the medium/long term.
- Special Drawing Rights:
- The SDR is an international reserve asset, created by the International Monetary Fund (IMF) in 1969 to supplement its member countries’ official reserves.
- The SDR is neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. SDRs can be exchanged for these currencies.
- The value of the SDR is calculated from a weighted basket of major currencies, including
- The US dollar
- The euro
- Japanese yen
- Chinese yuan
- British pound.
- The interest rate on SDRs, or (SDRi) is the interest paid to members on their SDR holdings.
- Reserve position with the IMF:
- A reserve tranche position implies a portion of the required quota of currency each member country must provide to the IMF that can be utilised for its own purposes.
- The reserve tranche is basically an emergency account that IMF members can access at any time without agreeing to conditions or paying a service fee.
Reasons behind the drop in India’s forex reserves
- Appreciation of the US dollar:
- The demand for dollars remained high as the Russia-Ukraine war led to a spike in oil and commodity prices.
- Capital outflows by foreign portfolio investors (FPIs):
- FPIs pulled out $21.43 billion since September 2021 as the US Federal Reserve started monetary policy tightening and interest rate hikes.
- The effect of gold prices:
- The decline in gold prices has also played a part in the decline in foreign exchange reserves.
Impact of foreign reserves declining
- It may lead to financial issues:
- A decrease in forex reserves may cause issues for the government and the RBI in managing the nation’s external and internal financial issues.
- It may affect import cover:
- Higher forex provides a big cushion in the event of any crisis on the economic front as it provides cover to the import bill of the country for a year.
Pic courtesy: Mint
Content Source: The Hindu