What are Forex Reserves ?
Forex reserves are assets held by central of of any country in foreign currency, SDRs or gold.
Components of Forex Reserves(In India) :
The Forex reserves in India comprise of Foreign Currency assets (FCAs), Special Drawing Rights (SDRs), Reserve Tranche with IMF and Gold.
Foreign Currency Assets (FCAs) :
This is the largest component of the Forex Reserves consisting of US dollar and other major global currencies such as Euro, Pound, yen etc. Additionally, it also comprises investments in US Treasury bonds, bonds of other selected governments, deposits with foreign central and commercial banks.
Even though, Foreign Currency Assets (FCA) is maintained in major currencies, the foreign exchange reserves are denominated and expressed in US dollar terms.
Special Drawing Rights (SDRs) :
The SDRs was created by the International Monetary Fund (IMF) as an international reserve asset in the year 1969 to supplement its member countries’ official reserves. The SDRs are allocated to member countries in proportion to their IMF quotas.
The value of the SDR is based on a basket of five currencies—the U.S. dollar, the Euro, the Chinese Renminbi, the Japanese Yen, and the British Pound Sterling. The value of SDR is set daily by the IMF on the basis of exchange rates between the currencies included in SDR. The value of SDR is denominated in terms of dollars.
Uses of SDRs :
- SDRs can be held as part of Forex Reserves
- SDRs can be exchanges into other freely usable currencies among themselves. (This signifies that SDR is neither claim nor currency of IMF Rather, it is potential claim on freely usable currencies of IMF members)
- IMF members can also use SDRs in their transactions with IMF such as repayment of loans, payment of interest, payment for increasing their IMF quota and so on.
- Members can sell a part or all their SDR allocations.
Reserve Position in the IMF:
The subscription of the quota consists of two components: (i) foreign exchange component and (ii) domestic currency component. Under the foreign exchange component, a member is required to pay 25 per cent of its quota in SDRs or in foreign currencies. This is termed as “reserve position in the IMF or reserve tranche” and is part of the member country’s reserve assets.
Reasons for increase in the Forex Reserves :
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Appreciation in Non-Dollar Major Currencies :
The Foreign currency assets is held in the form of major currencies like Dollar, Euro, Pound, Yen etc. but it is expressed in terms of dollars. The value of the Foreign Currency assets could change on account of increase or decrease in the value of the non-dollar major currencies. In last 2-3 months, the dollar has depreciated by around 4.5% vis-à-vis other currencies such as Euro, Pound, Yen etc. This increase in the value of other major currencies has led to increase in Forex Reserves.
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Decrease in Crude oil Prices :
The decrease in the Crude oil prices also meant decrease in our oil import bill and thus saving our Forex Reserves. -
RBI’s Intervention :
The RBI has also intervened in the Forex Market to buy dollars and enhance the Forex Reserves.
How the increase in the forex reserves would benefit India?
An important indicator of the stability of a currency is import cover. It measures the number of months of imports that can be covered with foreign exchange reserves available with the central Bank. The rising forex reserves have led to an improvement in India’s import cover to around 14 months. Further, an increase in the forex reserves will give the RBI the firepower to act against any sharp depreciation in the value of Rupee.
