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Rising forex reserves and its importance

Topics Covered: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

Rising forex reserves and its importance

What to study?

For Prelims: Components of Forex reserves.

For Mains: Rising forex- reasons, significance and how to utilise it?

Context: Amid pandemic, India’s foreign exchange reserves are rising and are slated to hit the $500 billion mark soon.

In the month of May, forex reserves jumped by $12.4 billion to an all-time high of $493.48 billion (around Rs 37.30 lakh crore) for the week ended May 29.

Important fact for Prelims:

The level of foreign exchange reserves has steadily increased by 8,400 per cent from $5.8 billion as of March 1991 to the current level.

What are forex reserves?

Forex reserves are external assets in the form of gold, SDRs (special drawing rights of the IMF) and foreign currency assets (capital inflows to the capital markets, FDI and external commercial borrowings) accumulated by India and controlled by the Reserve Bank of India. 

Why they are important?

  1. Official foreign exchange reserves are held in support of a range of objectives like supporting and maintaining confidence in the policies for monetary and exchange rate management including the capacity to intervene in support of the national or union currency.
  2. It will also limit external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed.

Why are forex reserves rising despite the slowdown in the economy?

Rise in investment in foreign portfolio investors in Indian stocks and foreign direct investments (FDIs).

Fall in crude oil prices has brought down the oil import bill, saving the precious foreign exchange.

Overseas remittances and foreign travels have fallen steeply – down 61 per cent in April from $12.87 billion.

What’s the significance of rising forex reserves?

The rising forex reserves give a lot of comfort to the government and the Reserve Bank of India in managing India’s external and internal financial issues at a time when the economic growth is set to contract by 1.5 per cent in 2020-21.

It’s a big cushion in the event of any crisis on the economic front and enough to cover the import bill of the country for a year.

The rising reserves have also helped the rupee to strengthen against the dollar.

Reserves will provide a level of confidence to markets that a country can meet its external obligations, demonstrate the backing of domestic currency by external assets, assist the government in meeting its foreign exchange needs and external debt obligations and maintain a reserve for national disasters or emergencies.

Where are India’s forex reserves kept?

The RBI Act, 1934 provides the overarching legal framework for deployment of reserves in different foreign currency assets and gold within the broad parameters of currencies, instruments, issuers and counterparties.

As much as 64 per cent of the foreign currency reserves is held in the securities like Treasury bills of foreign countries, mainly the US.

28 per cent is deposited in foreign central banks.

7.4 per cent is also deposited in commercial banks abroad.

India also held 653.01 tonnes of gold as of March 2020, 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.

InstaLinks:

Prelims Link:

  1. Components of forex reserves?
  2. Who handles it?
  3. Does RBI earn any returns on them?
  4. Trends in forex reserves over the last decade.

Mains Link:

Discuss how rising forex reserves are beneficial for India’s economy.

Sources: Indian Express.