India’s forex reserves
GS PAPER III: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.
Context: Reserve Bank of India (RBI) Governor said India’s forex reserves may have crossed record level of $600 billion on the back of robust capital flows.
- To boost liquidity, the RBI announced several steps including a special liquidity facility for various sectors impacted by the COVID-19 pandemic.
- The Central bank also announced G-sec Acquisition Programme (G-SAP) 2.0 which will help in calming yields and control undue volatility faced by market participants in the government securities market.
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 RBI.
- The International Monetary Fund says 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.
- It also limits 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?
- 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.
What’s the 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.
What does the RBI do with the forex reserves at its disposal?
- 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.
- When the RBI mops up dollars, it releases an equal amount in rupees. This excess liquidity is sterilised through the issue of bonds and securities and LAF operations.