What is the issue?
India’s foreign exchange reserves have now fallen below the $600 billion mark amid capital outflows and strengthening dollar.
What are foreign exchange reserves?
- Foreign exchange reserves are assets denominated in a foreign currency that are held by a central bank.
- These may include foreign currencies, bonds, treasury bills, and other government securities.
- These assets are held to ensure that a central government agency has backup funds if their national currency rapidly devalues or becomes all together insolvent.
- It helps to check the balance payments and influences the foreign exchange rate of its currency and maintains stability in financial markets.
- The two most popular foreign assets are US dollar-denominated assets and euro-denominated assets.
- China is the largest foreign currency reserve holder in the world.
What about the composition of FCAs?
- The FCAs comprise multi-currency assets that are held in multi-asset portfolios as per the existing norms conforming to the best international practices.
- The forex reserves include
- Investments on foreign securities
- Investments on other central banks and the BIS
- Deposits with commercial banks overseas
- Gold holdings
What happened to the forex reserves of India?
- The foreign exchange reserves declined from $642.45 billion (September, 2021) to $597.72 billion (April 2022).
- The RBI’s special drawing rights and reserve position in the International Monetary Fund also dipped by $33 million and $26 million.
- Reasons for the decline
- Fall in foreign currency assets (FCAs) - The foreign currency assets also include the effect of appreciation or depreciation of non-US units like the euro, pound and yen held in the reserves.
- Appreciation of the US dollar- The demand for dollars remained high as the Russia-Ukraine war led to a spike in oil and commodity prices.
- Capital outflows by foreign portfolio investors (FPIs) - FPIs pulled out $21.43 billion since September 2021 as the US Federal Reserve started monetary policy tightening and interest rate hikes.
- Effect of gold prices- Decline in gold prices has also played a part in the decline in foreign exchange reserves.
What is the impact on the rupee?
- The rupee depreciated 57 paise and touched a low of 76.96 just below the all-time low of 76.97 to close at 76.92 against the US dollar.
- If the rupee slides further, the RBI will be forced to intervene in the forex market by selling dollars from its forex reserves.
- If the RBI gives preference to sustain the forex reserves level, there could be some rupee depreciation in the horizon.
References
- https://indianexpress.com/article/explained/explained-india-foreign-exchange-dip-7905564/
- https://timesofindia.indiatimes.com/business/india-business/forex-kitty-dips-42bn-in-8-months-to-600bn/articleshow/91190754.cms
- https://www.investopedia.com/terms/f/foreign-exchange-reserves.asp
