Forex reserves, importance, advantages, meaning for UPSC IAS exam (2024)

‘Forex reserves’ is an important term in economics and its understanding is necessary to understand how an economy functions with respect to international trade and commerce. In this article, we give you a brief about forex reserves for the Civil Services Exam.

What is Foreign Exchange Reserve or Forex Reserve?

Forex reserves or foreign exchange reserves (FX reserves) are assets that are held by a nation’s central bank or monetary authority. It is generally held in reserve currencies usually the US Dollar and to a lesser degree the Euro, Japanese Yen, and Pound Sterling. It is used to back its liabilities – like the native currency issued and also reserves deposited by financial institutions or the government with the central bank.

Objectives Behind Holding Forex Reserves:

• Supporting and maintainingconfidence in the policies for monetary and exchange rate management
• Provides the capacity to intervene insupport of the national or union currency.
• Limits external vulnerabilityby maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed.

In a conservative view, forex should only contain foreign banknotes, foreign treasury bills, foreign bank deposits, and long and short-term foreign government securities. But, in practice, it also contains gold reserves, IMF reserve positions, and SDRs, or special drawing rights. The latter figure is more easily available and is officially known as the international reserves.

This article will tell all you need to know about the topic ‘Forex Reserves’. Economics is an important segment of theIASexam and is also extensively linked to current affairs.

Forex Reserves Latest Updates

According to the Reserve Bank of India RBI Data, India’s foreign exchange (Forex) reserves increased by $3.074 billion in the week ended June 11. With this leap, the forex reserves have reached an all-time high of $608.081 billion, on June 18, 2021.

Details on the Reserve Bank of India are available on the page link provided here.

The surge in forex reserves this week can be attributed to an increase in foreign currency assets (FCA), the largest component of a country’s foreign exchange reserves.

Forex Reserves India

As of June 2021, India has USD $608.081 billion forex reserves. India ranks fourth in the world in forex reserves. China is in first position, followed by Japan and Switzerland.

Purpose of keeping foreign exchange reserves

1. To keep the value of their currencies at a fixed rate.
2. Countries with a floating exchange rate system use forex reserves to keep the value of their currency lower than the US Dollar.
3. To maintain liquidity in case of an economic crisis.
4. The central bank (RBI) supplies foreign currency to keep markets steady.
5. To ensure that a country meets its foreign obligations and liabilities.

To know more about theForeign Exchange Management Act,visit the linked article.

Reasons for High Forex Reserves

• Rise in investment byforeign portfolio investorsandincreasedforeign direct investments(FDIs). Know in detail about the Foreign Direct Investment – FDI on the linked page.
  • The sharp jump in reserves started with the Finance Ministry’s announcement in 2019,cuttingcorporate taxrates.
• Fall in crude oil priceshas brought down the oil import bill, saving precious foreign exchange.
• Dollar outflowfromoverseas remittances and foreign travelshave fallen steeply.

Importance of foreign exchange reserves

According to a report by Goldman Sachs, stronger foreign currency reserves will allow developing market central banks to “buffer their currencies against sharp declines by supplying dollars to the market” at times of volatility.

Importance of Increasing Foreign Exchange Reserves

• The government is in a comfortable position if there arerising forex reservesand the RBI in managing India’sexternal and internal financial issuesat a time ofmajor contraction (23.9%) in economic growth.
• ItAssist the government in meeting itsforeign exchange needs and external debt obligations.
• Appreciation in Rupee –The rising foreign exchange reserves has helped therupee to strengthen against the dollar.
• Crisis Management:Rising Forex Reserve serves as acushion in the event of aBalance of Payment crisison the economic front. It isenough to cover the import billof the country for a year. Know more about the Balance of Payment on the linked page.
• Confidence in the Market: Forex Reserves will provide a level ofconfidence to markets and investorsthat a country can meet its external obligations

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