Foreign Exchange Reserve

Foreign Exchange Reserve

Subject : Economy

Context: India has sufficient forex reserves to finance CAD and intervene in forex market: Eco Survey

Findings in Economic Survey:

• India’s forex reserves, as on January 20, stood at $573.727 billion.
• The country recorded a current account deficit of 3 per cent of GDP in H1 FY23
• Reason for rising CAD
  • Sharp increase in the merchandise trade deficit.
  • Current Account Balance stems from a swift recovery driven mainly by domestic demand and, to a lesser extent, by exports.
  • It have added to the domestic inflationary pressures besides widening the CAD.
  • Global commodity prices may have eased but are still higher compared to pre-conflict levels. They have further widened the CAD, already enlarged by India’s growth momentum.
• The survey underscored that the scenario of subdued global growth presents two silver linings – oil prices will stay low, and India’s CAD will be better than currently projected. The overall external situation will remain manageable.
• As of end-November 2022, India was the sixth largest foreign exchange reserves holder in the world according to data compiled by the IMF.
• The import coverage of foreign currency reserves has declined since the pre-pandemic levels in most emerging market economies; however, that of India has increased from 95 per cent in Q4 2019 to 96.5 per cent in Q3 2022.
• There is a cost involved in holding them and they are subject to diminishing returns. The costs borne by an economy for holding FER include the opportunity cost, in terms of the difference between domestic and foreign borrowing rates and loss due to the value reduction in the denominated FER.
• The survey points out that it examines the social cost of FERs and finds that the income loss to most developing countries amounts to close to one per cent of GDP.

Foreign Exchange Reserve:

• Foreign exchange reserves are assets held on reserve by a central bank in foreign currencies, which can include bonds, treasury bills and other government securities.
• It needs to be noted that most foreign exchange reserves are held in US dollars.

India’s Forex Reserve include:

• Foreign Currency Assets
• Gold reserves
• Special Drawing Rights
• Reserve position with the IMF
• Foreign Currency Assets:
• • 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 unitslike 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 and this has been proved time and again.
• 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, and British pound.
  • The interest rate on SDRs or (SDRi)is the interest paid to members on their SDR holdings.
• Reserve Position in the International Monetary Fund:
  • A reserve tranche position implies a portion of the required quota of currency each member country must provide to the IMF that can be utilized 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.

Significance of rising forex reserves:

• The rising forex reserves give comfort to the government and the RBI in managing India’s external and internal financial issues at a time of major contraction in economic growth.
• It serves as a cushion in the event of a crisis on the economic front, and is 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. The foreign exchange reserves to GDP ratio is around 15 per cent.
• 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.