On India’s Forex Reserves – Decoding the fall and rise of India’s forex reserves

Source: This post on India’s Forex Reserves has been created based on the article “Decoding the fall and rise of India’s forex reserves” published in “Live Mint” on 6^th December 2023.

UPSC Syllabus Topic: GS Paper 3 Indian Economy and issues relating to planning and mobilization of resources.

News: The article discusses the recent rise of India’s foreign exchange reserves. It highlights the various components of forex reserves as well as the mechanisms of RBI’s interventions involving them.

India’s Forex Situation:

On 14 July, India’s foreign exchange (forex) reserves stood at $609 billion. On 20 October, it hit a recent low of $583.5 billion before rising again slightly to $597.9 billion on 24 November.

What are India’s forex reserves?

Primarily, foreign exchange reserves consist of foreign currency assets and gold.

1 Gold:

Gold reserves are maintained for financial emergencies.

As per the latest data, gold has risen to around 7.7% of foreign exchange reserves of $597.9 billion (from 7% $530 billion a year earlier).

This has primarily been on account of the price of gold in dollar terms going up by close to 15% in the last one year.

2 Foreign Currency Assets (FCAs):

This constitutes major global currencies like the US dollar, euro, pound sterling, Japanese yen, etc., held in the form of securities such as treasury bills, bonds, and deposits in foreign central banks. It forms the majority of India’s forex.

These are used by the Reserve Bank of India (RBI) to actively manage the value of the rupee against the dollar.

Apart from this, forex also consists of:

3 Special Drawing Rights (SDRs): SDRs are allocated to member countries of the IMF, including India, and serve as an additional reserve asset. The SDR is not a currency. It is a potential claim on the freely usable currencies of IMF members.

4 Reserve Position in IMF: It represents the funds held in the IMF that a country can use based on its membership quota. Part of the quota can be withdrawn from the IMF during critical situations such as Balance of Payment (BOP) crises.

How does forex reserve help RBI in managing the value of the Rupee?

For India’s macroeconomic stability, it is important that the rupee does not depreciate too much and/or too fast against the dollar.
For instance, India imports much of the oil that it consumes (more than 80%). In such a scenario, a weaker rupee makes oil imports expensive, (which passes on to either the end-consumers or the primarily government-owned oil marketing companies). This makes it important for the RBI to ensure that the value of the rupee doesn’t fall too much and too fast against the dollar.

The RBI secures this stability by selling the dollars from its reserve of foreign currency assets and acquiring rupees in return. This practice ensures availability of dollars in the economy, thereby averting swift devaluation of the rupee against the dollar.

Why did the Forex reserves recently go down?

Recently, the Rupee has come under pressure of depreciating. This is because the returns on US government bonds have been going up. Higher returns led foreign institutional investors (FIIs) to sell Indian stocks and move money to USA (because investors opt for safer investment options).

In order to move this money out of India they had to sell rupees and buy dollars. This put pressure on the rupee, forcing the RBI to act.

Why have the Forex reserves now gone up?

The return on the US government bond fell in November. The fall in returns has encouraged FlIs to bring money back into India.

So, with FII dollars coming into the country again, the RBI doesn’t need to sell its dollar reserves anymore to prevent the depreciation of rupee. This is why forex reserves have risen to close to $598 billion.

Question for practice:

Healthy foreign exchange reserves are fundamental to India’s macroeconomic stability. In light of this, discuss the role of RBI in forex reserve management.