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Forex Reserves
Context:
India’s forex reserves fell by $2 billion after reaching an all-time high of $648.7 billion according to the Reserve Bank of India.
About India’s Forex reserves:
- Forex reserves refer to the assets denominated in foreign currencies held by the RBI.
- The Reserve Bank of India 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.
- India’s Forex Reserve include:
- Foreign Currencies:
- Foreign currency reserves are the most significant part of India’s forex reserves.
- The largest component of the forex reserve.
- They consist of major currencies like the US Dollar, Euro, and British Pound, providing liquidity and facilitating international trade transactions.
- It facilitates international trade, provides liquidity and enhances stability and confidence.
- Foreign Currencies:
- Gold:
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- Gold reserves serve as a hedge against inflation and provide stability during economic uncertainties.
- Including gold in the reserves adds value and security, reflecting its traditional significance in the Indian economy.
- Special Drawing Rights (SDRs):
- SDRs are international reserve assets created by the IMF to supplement member countries’ foreign exchange reserves.
- They enhance international liquidity and contribute to stabilising the global monetary system.
- Reserve Portion in IMF:
- The reserve portion in the IMF reflects India’s allocated share and voting rights in the International Monetary Fund, showcasing India’s role and influence in this global financial institution.
Why India Accumulates, Increases or Decreases Forex reserves?
- Growth and Stability: Forex Reserves provide stability as they increase the confidence of foreign investors to invest in the country.
- Trade Balance: A positive trade balance (exports greater than imports) can lead to an accumulation of forex reserves.
- A negative trade balance may require using funds to pay for imports.
- Inflation Control: The central bank may buy or sell foreign currency from its reserves to control inflation.
- Political Stability: Forex reserves help to deal with extraordinary situations like the 1991 oil crisis helping in a stable political environment.
- International Relations: Diplomatic relations with trading partners and international organisations can influence the flow of foreign capital.
- Global Economic Conditions: The state of the world economy affects foreign investment, trade, and, consequently, forex reserves
- Exchange Rate Fluctuations: Changes in currency exchange rates can lead to gains or losses in the forex reserves of India.
- International Crises: During Financial crises, pandemics, or geopolitical tensions foreign reserves act as a cushion.
Impact of Foreign reserves on the Indian economy:
Positive Impacts:
- Stabilisation of Currency: The Indian forex reserves help stabilise the native currency by allowing the government to intervene in the foreign exchange market.
- Enhanced Creditworthiness: Having substantial reserves improves India’s credit rating, attracting foreign investments.
Negative Impacts:
- Opportunity Cost: Holding large reserves means funds are not invested elsewhere, leading to potential opportunity costs.
- Inflationary Pressures: Excessive resources can lead to inflationary pressures within the economy.