Focus: GS-III Indian Economy
- India’s foreign exchange (forex) reserves surged by more than 3.5 billion Dollars to touch a lifetime high despite the current Pandemic Situation.
- Although the Covid Pandemic is likened to one the worst crises that the country has faced, the current situation stands in stark contrast to the one in 1991, when India had to pledge its gold reserves to stave off a major financial crisis.
- While the overall situation on the economic front is gloomy, with India’s Gross Domestic Product (GDP) growth having contracted 23.9 per cent in the April-June quarter, and manufacturing activity and trade at standstill, the stock of forex reserves is one data point that India can cheer about amidst the Covid-19 pandemic.
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.
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.
- On the other hand, the fall in crude oil prices has brought down the oil import bill, saving precious foreign exchange.
- Similarly, overseas remittances and foreign travels have fallen steeply.
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 uses its forex kitty for the orderly movement of the rupee.
- 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.
Where are India’s forex reserves kept?
- 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 deposited in commercial banks abroad, according to RBI data.
- India also held more than 650 tonnes of gold as of March 2020.
Is there a cost involved in maintaining forex reserves?
- The return on India’s forex reserves kept in foreign central banks and commercial banks is negligible — analysts say it could be around 1 per cent, or even less than that, considering the fall in interest rates in the US and Euro zone.
- There was a demand from some quarters that forex reserves should be used for infrastructure development in the country.
- However, the RBI had opposed the plan. Several analysts argue for giving greater weightage to return on forex assets than on liquidity thus reducing net costs if any, of holding reserves.
-Source: Indian Express