Decline in Forex Reserves

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Context

According to the Reserve Bank of India (RBI), India’s forex reserves have fallen by USD 110 billion in the last 13 months.

Relevance:

GS III: Indian Economy

Dimensions of the Article:

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 Reserve Bank of India.
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 will also limit external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed.

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.

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 counterparties.
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 also deposited in commercial banks abroad, according to the RBI data.

Since September 2021, when they reached a record high of USD 642.45 billion, India’s foreign exchange reserves have decreased by USD 110 billion.
It should be remembered that the Indian rupee is a freely floating currency, and that the market determines its exchange rate. There is no set exchange rate set by the RBI.
India has performed significantly better than several reserve currencies, EMEs (emerging market economies), and its Asian competitors despite this sharp decrease.

The central bank has been selling dollars from the forex reserves to support the rupee amid pressures caused majorly by global developments.
- The intervention is needed to curb the free fall of the rupee and reduce volatility in the market.
Capital outflows by foreign portfolio investors (FPIs) as the US Federal Reserve started the monetary policy tightening and interest rate hikes.
- FPIs have begun to withdraw from the Indian markets. These FPIs were sellers in financial and IT services and buyers in telecom and capital goods.
The valuation loss, reflecting the appreciation of the US dollar against major currencies and the decline in gold prices also played a part in the decrease in foreign exchange reserves.
- About 67% of the decline in reserves during the current financial year was due to valuation changes arising from an appreciating US dollar and higher US bond yields.

Source: Indian Express