Forex Reserves and Their Benefits

The Reserve Bank of India (RBI) is in charge of the country’s foreign exchange reserves. According to RBI data, India’s total forex reserves were USD 352 billion (INR 23,415 billion) as of December 4, 2015, including USD 329 billion in foreign currency assets, USD 17 billion in gold, USD 4.0 billion in SDRs, and USD 1.2 billion in IMF reserve positions.

What constitutes a sufficient level of currency reserves for any emerging economy is a highly subjective matter. Around two decades ago, a forex reserve that could cover three to six months’ worth of imports was deemed appropriate, but global trade and finance patterns have modified the sufficiency requirements for forex reserves. The adequacy requirements now take into account not only the import bill, but also the ratio of reserves to short-term debt, as a percentage of foreign debt, the ratio of reserves to GDP, as a percentage of current account deficit (CAD), and capital account inflow and outflow changes. By any measure, India’s foreign exchange reserves are currently sufficient.

Here’s a brief note on Forex Reserves and Their Benefits!

What is the use of forex reserves?

Because all foreign transactions are completed in US dollars, we must rely on them to fund our imports. They are also required to sustain and maintain confidence in central bank activity, whether it be monetary policy or exchange rate intervention to support the home currency. Talking about the use of forex reserves, it helps to limit any vulnerability that may arise as a result of a rapid disruption in international money flows, which may occur during a crisis. Having liquid currency on hand protects against these consequences and ensures that the country’s critical imports will continue to be supported in the event of external shocks.

The Benefits of Forex Reserves

The forex’s main advantage is that it may be used to meet international financial obligations such as governmental and commercial debts, as well as funding imports. Let’s discuss the benefits of high forex services.

• It aids in increasing market confidence in a country’s ability to meet its external obligations.
• It works as a shock absorber for unexpected external shocks. India was able to weather the global financial crisis of 2008 because of significant foreign reserves.
• Increases international investor confidence, increasing foreign direct investment (FDI). 
• The forex reserves are used by the RBI to modify the foreign exchange rate. In the event of a severe drop in the Rupee’s foreign exchange value, the RBI sells the Dollar, causing the Rupee to appreciate. 
• The foreign currency assets are mostly invested in international instruments with the highest credit ratings and no credit risk.

How do Foreign Exchange Reserves work?

After discussing the benefits of high forex reserves, it’s important to understand how they function. Exporters in the country deposit foreign currency in local banks. The currency is transferred to the central bank. Exporters are paid in US dollars, euros, or other currencies by their trading partners. They are exchanged for the local currency by the exporters. It is used to pay their employees and local vendors.

Since the sovereign yields a low-interest rate, banks prefer to use cash to purchase it. Treasury notes are the most popular since most international trade is conducted in the US dollar due to its status as the world’s reserve currency. Banks are buying more euro-denominated assets, such as high-quality corporate bonds, to diversify their portfolios. Despite the eurozone crisis, this continues. They’ll get gold and special sketching rights as well. Any reserve amounts they’ve deposited with the International Monetary Fund are the third asset.

What is the location of India’s foreign exchange reserves?

Within the broad limitations of currencies, instruments, issuers, and counterparties, the RBI Act of 1934 establishes the main legislative structure for the deployment of reserves in various foreign currency assets and gold. According to RBI data, 64 percent of foreign currency reserves are held in assets such as Treasury bills issued by other governments, particularly the United States, 28 percent by foreign central banks, and 7.4 percent by financial institutions in other nations.

As of March 2020, India owned 653.01 tonnes of gold, with 360.71 tonnes stored in safe custody with the Bank of England and the Bank for International Settlements, and the remainder held domestically. The share of gold in total foreign exchange reserves climbed from about 6.14 percent at the end of September 2019 to roughly 6.40 percent at the end of March 2020 in value terms (USD).

Conclusion

That’s a wrap to the brief note on  Forex Reserves and Their Benefits!

Foreign Exchange Reserves, or Forex reserves, are assets that are held by a central bank or other monetary authority to check balances, influence the foreign exchange rate of its currency, and maintain financial market stability. The foreign exchange reserve is akin to an economy’s health metre. At the international level, a country’s financial situation is deemed to be very sound if it possesses a sizable FX reserve.