Swelling Foreign Exchange Reserves Can Help India’s Economy Grow

Swelling Foreign Exchange Reserves Can Help India’s Economy Grow

17 Aug 2019 10:55 AM

For any country, maintaining forex reserves is essential as it helps in maintaining the economic wellbeing of any nation. Especially for a country like India, the more Forex reserve our country manages to maintain the better it is for the nation. We have higher imports as against lower export earnings and in order to help our country’s economy grow faster, maintaining a higher forex reserve is one of the convincing way out.

In India, the Reserve Bank of India (RBI) enables the development of foreign exchange market. This body ensures smooth functioning of the domestic forex market and keeps a track on how India’s foreign currency assets and gold reserves can be managed well. India’s foreign exchange reserves include the following components-

  1. Foreign currency assets (FCA)- This constitutes largest components of Indian Forex Reserves and are expressed in US dollar terms
  2. Reserve Tranche Position (RTP) of RBI with IMF
  3. Gold reserves
  4. Special Drawing Rights (SDRs)

Before directly discussing the current state of forex reserves in India, let’s first understand the definition of forex reserves first and then check how our Central Bank of India manages to bring boost foreign reserves in India.

Foreign Exchange Reserves: Definition

Put simply, foreign exchange reserves imply foreign currencies held by a country’s central bank. One of the fundamental reasons why countries hold currency is mainly to manage the value of the domestic currency, maintain the stability of the currency and control inflation. This is done mainly by buying and selling foreign currency assets periodically in the spot and forward currency markets.

Secondly, Central banks hold foreign currency in order to maintain the liquidity in times of economic crisis. In those times, the Central bank of any country can use those reserves to exchange its foreign currency for their local currency to pay for and receive imports.

The third reason behind holding foreign currency in the reserves is to make adequate utilization of such reserves to fund sectors such as infrastructure. Here, central banks aim to encourage returns without putting safety at stake. Banks tend to diversify their portfolio and for this, they hold gold and other safe, interest bearing investments.

Fourthly, by holding foreign currency individual countries gain confidence to ensure foreign investors that they are ready to take action in order to protect their investments. A strong position in foreign currency reserves helps prevent economic crises caused when any event triggering a flight to safety for any country.

Fifthly, reserves are also required to ensure a country is able to maintain its external obligations; that include international payment obligations, including sovereign and commercial debts. It also includes financing of imports and the ability to absorb any unexpected capital movements.

The sixth proposition is that countries with a floating exchange rate system use reserves to keep the value of their currency lower than the dollar. They mainly do it with fixed rate systems.

Current State of Forex Reserves in India

As declared by RBI data, the forex reserves in India had reached its record high levels of $429.91 billion recently. This rise was mainly contributed due to a rise in the gold reserves in India by a level of $3.65 billion. The foreign currency assets also reflect a change in valuation by a margin of $906.8 million to $400.81 billion over a week.

Last year too, the Indian forex reserves had scaled a record high of $426.028 and ever since that, there has been a rise and fall witnessed in this levels. Ever since that, RBI had been intervening in the market to salvage Indian rupee as it was performing really bad compared to all the Asian currencies.

The good news about Indian economy is that, after the general election’s result recently, foreign investors may be keen to invest in India. With dollar inflows, the rupee appreciated which led the RBI to purchase dollar assets in the forward market.

Further, other reasons which are considered to be the contributing factors for the current rise in forex reserve levels are- crash of Turkey’s lira, Crude oil prices rising and US China trade war. All these factors had pushed the Reserve Bank of India to cut down its reserves and keep rupee at a stable position and check it from depreciating against Dollar.

Looking at the current instability in the state of world trading ecosystem as major developed countries like US is increasingly adopting protectionist movement; RBI has decided to augment its gold reserves. This measure will help avoid major drawbacks of currency shock and dovish global monetary policy. Gold has always been considered as a safe haven asset and therefore chalking out an effective portfolio helps diversify the mid-term investment choice.

However, as per the recent RBI data, one finds the massive rally in gold prices there was no change recorded in the levels of gold reserves. It remained at $24.304 billion. Similarly, special drawing rights with the IMF fell by $ 1.2 million to $ 1.450 billion reserve position with the fund too fell by $1.5 million to $3.345 billion.

For a healthier balance of the Indian economy, maintaining higher forex reserve is essential. Diversifying the Asset Management strategies is also important to upscale the returns on foreign reserves. With global events challenging the forex market in invariable manner, dovish and hawkish currency policies can bring about a total u turn in the currency rates overnight. Thus, for the Indian importers, exporters and investors taking measured Forex Exchange and Risk Management steps to safeguard their forex exposure and asset levels has become highly significant in the present time. Forex risk advisory is an integral part of forex services and this helps businesses to manage forex payments for imports or exports in gainful ways.

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