Q. Consider the following statements with reference to the ‘Forex Reserves’:
1.Trade surpluses, current account balances, and exchange rates are the main components of forex reserves.
2.Foreign exchange reserves help a country manage its exchange rate by influencing the supply and demand for its currency.
3.A higher amount of foreign exchange reserves leads to a lower credit rating.
Which of the statement(s) given above is/are correct?
Explanation –
Statements 1 and 3 are incorrect. Trade surpluses, current account balances, and exchange rates are indicators of a country’s foreign exchange position, not the components of forex reserve themselves. The main components of forex reserves are: Gold, Foreign currency holdings, Special Drawing Rights (SDRs). A higher level of foreign exchange reserves is often viewed positively by credit rating agencies. Adequate reserves indicate a country’s ability to meet its external obligations and provide a buffer against external shocks. Therefore, higher reserves can contribute to a higher credit rating, as they enhance a country’s ability to repay its debts and manage financial risks effectively.
Statement 2 is correct. Foreign exchange reserves allow a country’s central bank to intervene in the foreign exchange market, buying or selling its own currency to influence its exchange rate. By adjusting the supply of its currency in the market, the central bank can impact its exchange rate and maintain stability.
Source: Mint
