Forex reserve

Subject: Economy

Context:

Reserve Bank of India (RBI) data showed  India’s foreign exchange (forex) reserves surged by $3.883 billion to touch a lifetime high of $541.431 billion in the week ended August 28.

Concept:

• 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 RBI.
• The major reason for the rise in forex reserves is the rise in investment in foreign portfolio investors in Indian stocks and foreign direct investments (FDIs). Foreign investors have acquired stakes in several Indian companies over the past several months.
• There is also fall in crude oil prices which brought down the oil import bill, saving precious foreign exchange. Similarly, overseas remittances and foreign travels have fallen steeply.

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.

Role of RBI

• The Reserve Bank functions as the custodian and manager of forex reserves, and operates within the overall policy framework agreed upon with the government.
• The RBI allocates the dollars for specific purposes. For example, under the Liberalised Remittances Scheme, individuals are allowed to remit up to $250,000 every year.
• The RBI uses its forex kitty for the orderly movement of the rupee. It sells the dollar when the rupee weakens and buys the dollar when the rupee strengthens. Of late, the RBI has been buying dollars from the market to shore up the forex reserves.
• 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 counter parties.
• As much as 64 per cent of the foreign currency reserves are held in securities like Treasury bills of foreign countries, mainly the US; 28 per cent is deposited in foreign central banks; and 7.4 per cent is deposited in commercial banks abroad, according to RBI data.
• The return on India’s forex reserves kept in foreign central banks and commercial banks is negligible