Topic: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.
Q5. Discuss the economic significance of foreign exchange reserves for a developing economy like India. Examine the factors responsible for pressure on India’s forex reserves in recent years. Evaluate the limitations of reserve depletion as a strategy to defend the rupee. (15 M)
Difficulty Level: Medium
Reference: IE
Why the question
India’s external sector has faced pressures due to global geopolitical instability, rising import bills, and exchange-rate volatility. The question examines the importance of forex reserves in maintaining macroeconomic stability.
Key Demand of the question
The question requires explaining the economic significance of forex reserves for India and analysing the major factors behind recent pressures on reserves. It also demands evaluation of why excessive reserve depletion cannot be a sustainable strategy for defending the rupee.
Structure of the Answer:
Introduction
Briefly define forex reserves and mention their role as a buffer against external shocks and currency instability in developing economies.
Body
- Significance of forex reserves: Discuss their role in import security, exchange-rate stability, investor confidence, and macroeconomic resilience.
- Factors behind pressure on reserves: Explain issues such as rising crude oil imports, capital outflows, current account deficits, and RBI intervention in forex markets.
- Limitations of reserve depletion strategy: Analyse concerns like unsustainability, structural external weaknesses, investor signalling risks, and limited long-term effectiveness.
Conclusion
Conclude by highlighting that sustainable rupee stability depends more on export competitiveness, productivity growth, and structural reforms than continuous reserve drawdowns.
