India’s Forex Reserves rise to lifetime high of $621.5Bn (Explained)

India’s foreign exchange reserves increased by $835 million in the week ending July 16th, reaching a new high of $612.73 billion. The reserves increased to $611.895 billion from $1.883 billion in the week ending July 9th.

  • India’s foreign exchange reserves surpassed $600 billion, aided by the pandemic year, when a flood of global cash sought returns in emerging economies.
  • As a result, most emerging markets, including India, saw a build-up in foreign exchange reserves as central banks bought dollars to avert significant currency appreciation.
  • For the week ending June 4, 2021, India’s foreign exchange reserves increased to $605 billion, up from $598 billion the week before.
  • Since March-end 2020, when the Covid crisis intensified around the world, leading central banks to unleash a wall of money to stabilise economies, reserves have increased by about $130 billion.

According to a trend analysis over the last year, almost a sixth of India’s foreign exchange reserves piled up in the last year, with reserves rising $102 billion owing to strong foreign investments in Indian equities as well as a contraction in imports due to restricted economic activity caused by the pandemic-induced lockdown.

India Foreign Exchange Reserves
Foreign Exchange Reserves in India at an all-time high

Under profound recessionary conditions, a significant decrease in imports compared to exports led to a current account surplus; this, along with solid net capital inflows, contributed to a considerable build-up of foreign exchange reserves.

Statement: Reserve Bank of India

What are Forex Reserves?

The central bank or monetary authority of a country has forex reserves or foreign exchange reserves (FX reserves). It is commonly kept in reserve currencies such as the US Dollar, Euro, Japanese Yen, and Pound Sterling to a lesser extent. It is used to support its obligations, such as the local currency created and reserves placed with the central bank by financial institutions or the government.

Objectives Behind Holding Forex Reserves:

  • Providing support for and sustaining trust in monetary and exchange rate policy.
  • Allows for intervention in support of the national or union currency.
  • Reduces external vulnerability by keeping foreign currency liquidity on hand to absorb shocks during times of crisis or when borrowing is restricted.

Forex should only comprise foreign banknotes, foreign treasury bills, foreign bank deposits, and long and short-term foreign government securities, according to a conservative viewpoint. However, gold reserves, IMF reserve positions, and SDRs, or special drawing rights, are all included in practice. The latter amount, formally known as international reserves, is more readily available.

Why Keep Foreign Exchange Reserves

  • To maintain the value of their currencies at a constant level.
  • Floating exchange rate countries employ forex reserves to maintain their currency’s value lower than the US Dollar.
  • To ensure liquidity in the event of an economic downturn.
  • To keep markets stable, the central bank (RBI) distributes foreign currency.
  • Ensuring that a country’s international commitments and liabilities are met.

Foreign Reserves are Important, Here’s Why-

Stronger foreign currency reserves would help emerging market central banks to “buffer their currencies against severe falls by providing dollars to the market” during periods of turbulence, according to Goldman Sachs research.

We need to raise our ForEx reserves

  • It assists the government in meeting its foreign exchange demands and external debt commitments by increasing forex reserves and assisting the RBI in managing India’s external and internal financial difficulties during a time of substantial contraction (23.9 percent) in economic development.
  • Rupee Strengthening: The rupee has strengthened versus the dollar as foreign exchange reserves have increased.
  • Crisis Management: A growing Forex Reserve acts as a safety net in the case of an economic Balance of Payments crisis. It is sufficient to pay the country’s import cost for a year. On the linked page, you may learn more about the payment balance.
  • Market Confidence: Forex Reserves will provide markets and investors’ confidence that a country will be able to pay its foreign obligations.

The Miracle of 2021

  • While India benefited greatly from dollar flows, it was not the only one.
  • Despite this, India’s reserve accumulation is among the strongest among emerging nations.
  • Reserves have increased by about $140 billion since late 2019, making it one of Asia’s largest gains.
  • India’s reserve accumulation is among the greatest among emerging nations as a proportion of GDP.
  • India’s foreign currency reserve build-up was 4% of GDP in 2020, the most recent year for which comparable data is available.
  • After Taiwan, Hungary, and the Philippines, this is the fourth biggest.
  • India has the fifth-largest pool of foreign exchange reserves in absolute terms.

Is This Enough?

  • Reserves are more than adequate by most standard criteria at their current levels.
  • Based on typical monthly imports in FY20, before the pandemic, reserves are currently sufficient for more than 15 months of imports.
  • They are 1.1 times of India’s external debt of $563.5 billion as of December 2020.
  • Will the RBI be less active in buying foreign exchange now that its reserves are considered adequate?
  • According to experts, this is not the case.
  • According to recent policy comments, reserve accretion is a top goal for the central bank.
  • “This implies that they aren’t trying to meet any certain threshold, but that they believe it is important to reinforce this buffer at least for the length of the ultra-loose global policies.”

In Conclusion

An increase in forex reserves could provide some relief to the government and the Reserve Bank in managing the country’s external and internal financial issues at a time when the economy is once again experiencing Covid stress, and it could have an impact on the current fiscal’s GDP growth rate as states announce lockdowns.

It’s a significant buffer in the case of an economic downturn, and it’s enough to pay India’s import cost for a year. A larger currency reserve might also help the rupee gain ground versus the dollar.

A rise in reserves might reassure markets that a country can pay its external commitments, show that domestic currency is backed by overseas assets, help the government meet its foreign exchange demands and external debt obligations, and keep a reserve for national calamities or crises.

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Manan Patni
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