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Dip in Forex Reserves

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May 09, 2022

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.

forex-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

  1. https://indianexpress.com/article/explained/explained-india-foreign-exchange-dip-7905564/
  2. https://timesofindia.indiatimes.com/business/india-business/forex-kitty-dips-42bn-in-8-months-to-600bn/articleshow/91190754.cms
  3. https://www.investopedia.com/terms/f/foreign-exchange-reserves.asp

 

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