FOREIGN EXCHANGE RESERVES
1.Background
- Foreign exchange reserves are assets denominated in a foreign currency that are held by a nation's central bank.
- These may include foreign currencies, bonds, treasury bills, and other government securities.
- Most foreign exchange reserves are held in U.S. dollars, with China being the largest foreign currency reserve holder in the world.
- Economists suggest that it’s best to hold foreign exchange reserves in a currency that is not directly connected to the country’s own currency.
2.The reasons for holding reserves
- Typically, official foreign exchange reserves are held in support of a range of objectives including to:
- support and maintain confidence in the policies for monetary and exchange rate management including the capacity to intervene in support of the national or union currency;
- limit external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed and in doing so;
- provide a level of confidence to markets that a country can meet its external obligations;
- demonstrate the backing of domestic currency by external assets;
- assist the government in meeting its foreign exchange needs and external debt obligations; and
- maintain a reserve for national disasters or emergencies.
3.Objective of Reserve Management
Reserve management should seek to ensure that:
- adequate foreign exchange reserves are available for meeting a defined range of objectives; liquidity, market, and credit risks are controlled in a prudent manner; and
- subject to liquidity and other risk constraints, reasonable earnings are generated over the medium to long term on the funds invested.
4.India forex reserve include
- India's foreign exchange reserves include:
- Foreign Currency Assets
- Gold Reserves
- Special Drawing Rights (SDR)
- Reserve position with International Monetary Fund (IMF)
5.What determines Rupee Value
- The value of any currency is determined by demand for the currency as well as its supply.
- When the supply of a currency increases, its value drops.
- On the other hand, when the demand for a currency increases, its value rises.
- In the wider economy, central banks determine the supply of currencies, while the demand for currencies depends on the amount of goods and services produced in the economy.
- Determining Rupee value in Forex Reserves
- In the forex market, the supply of rupees is determined by the demand for imports and various foreign assets.
- So, if there is high demand to import oil, it can lead to an increase in the supply of rupees in the forex market and cause the rupee’s value to drop.
- The demand for rupees in the forex market, on the other hand, depends on foreign demand for Indian exports and other domestic assets.
- So, for instance, when there is great enthusiasm among foreign investors to invest in India, it can lead to an increase in the supply of dollars in the forex market which in turn causes the rupee’s value to rise against the dollar.
6.What’s causing the rupee to lose value against the dollar?
- Since March 2022, the U.S. The Federal Reserve has been raising its benchmark interest rate causing investors seeking higher returns to pull capital away from emerging markets such as India and back into the U.S.
- This, in turn, has put pressure on emerging market currencies which have depreciated significantly against the U.S. dollar so far this year.
- Even developed market currencies such as the euro and the yen have depreciated against the dollar and the dollar index is up more than 8% so far this year.
- In fact, some analysts believe that the RBI’s surprise decision to raise rates earlier this month may have simply been to defend the rupee by preventing any rapid outflow of capital from India.
- In 2013, the rupee fell 15% against the dollar in about three months after investors were spooked by the U.S. Federal Reserve’s decision to trim down its bond purchase programme that had helped keep long-term interest rates low.
- Moreover, India’s current account deficit, which measures among other things the gap between the value of imports and exports of goods and services, is expected to hit a 10-year high of 3.3% of gross domestic product in the current financial year as predicted by Morgan Stanly.
- This means that India’s import demand amid rising global oil prices is likely to negatively affect the rupee unless foreign investors pour sufficient capital into the country to fund the deficit.
- The rupee, it should also be noted, has consistently lost value against the U.S. dollar for several decades now.
- A major reason for this has been the consistently higher domestic price inflation in India.
- Higher inflation in India suggests that the RBI has been creating rupees at a faster rate than the U.S. Federal Reserve has been creating dollars.
- So, while capital and trade flows gain a lot of attention in discussions on the rupee’s value, the difference in the rates at which the U.S. Federal Reserve and the RBI regulate the supply of their currencies may play a much larger role in determining the value of the rupee over the long run.
7. Forex reserves of countries across the globe
Source - The Hindu
Reference- IMF, RBI.gov.in
