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India’s declining foreign exchange reserves

India’s declining foreign exchange reserves

According to data released by the Reserve Bank of India (RBI), the country’s foreign exchange reserves are declining. Although there has been an increase in the gold reserve component of foreign exchange reserves, other components of foreign exchange reserves, such as Special Drawing Rights (SDR), foreign assets and IMF’s “Reserve Trenches”, etc. have declined.

The main reason for the decline:

According to the Reserve Bank data, due to the fall in foreign currency assets (FCA), the exchange reserves have decreased. Foreign exchange assets form the major part of the total foreign exchange reserves.

Foreign Exchange Reserves

  • Foreign exchange reserves are funds or other assets held by the central bank of any country so that it can pay its liabilities when needed.
  • These reserves are kept in one or more currencies. Most dollars and to some extent euros are included in foreign exchange reserves.
  • Foreign exchange reserves are also called Forex reserves or FX reserves.
  • Adequate foreign exchange reserves are very important for a healthy economy.
  • It provides much needed help to the economy in the event of an economic crisis to support imports.
  • It consists of the IMF’s foreign currency assets, gold reserves and other reserves, of which foreign currency assets hold the largest share after gold.

Advantages of foreign exchange reserves:

  • Maintaining support and confidence in policies designed for monetary and exchange rate management.
  • In times of crisis, or when borrowing capacity is weakened, foreign exchange to address the crisis limits external influence while maintaining liquidity.
  • A country with a good foreign exchange reserve attracts a good share of foreign trade and earns the trust of trading partners.
  • This may encourage global investors to invest more in the country.
  • The government can also decide the immediate purchase of essential military goods as sufficient foreign exchange is available for payment.
  • In addition, foreign exchange reserves can play an effective role to reduce volatility in the foreign exchange market.

What are included in foreign exchange reserves?

  • Foreign Assets (shares, debentures, bonds, etc. of foreign companies in foreign currency)
  • Gold reserves
  • Reserve Trench in IMF
  • Special Drawing Rights (SDR)

Foreign Currency Assets (FCA)

  • Foreign currency assets are those that are valued in the currency of another country rather than that country’s own currency.
  • The FCA is the largest component of foreign exchange reserves. It is expressed in terms of dollars. Fluctuations in the prices of non-US currencies such as the euro, pound and yen are included in the FCA.

Gold Reserves:

  • Gold holds a special place in the foreign reserves of central banks as it is widely held for reasons of diversification.
  • With high quality and liquidity, gold is highly compatible with other traditional reserve assets, helping central banks conserve capital in the medium and long term, diversify portfolios, and mitigate risks.
  • Gold has consistently delivered better average returns than other alternative financial assets.

Reserve Tranche in IMF

A reserve tranche is a portion of the required quota of currency each member country must provide to the International Monetary Fund (IMF) that can be utilized for its own purposes—without a service fee or economic reform conditions.

Source – Indian Express

 

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