Forex reserves

Mains Marks Booster     5th August 2023        
output themes

Introduction

  • Forex reserves serve as the barometer of a country's economic health.
  • These reserves consist of assets like foreign currencies, gold reserves, and treasury bills, managed by the central bank.
  • Forex Reserves can be classified into four categories: Foreign currency assets (FCA), Investment in gold, Special drawing rights (SDRs) IMF, Reserve Tranche Position.

Objectives of Holding Forex Reserves

Objectives of Holding Forex Reserves

There are several objectives of holding forex reserves:

  • To support the country's balance of payments: A country with a balance of payments deficit can use its forex reserves to buy back its currency to prevent depreciation.
  • To stabilize the exchange rate: The central bank can stabilise exchange rates by buying and selling foreign currencies.
  • To provide a cushion in times of economic crisis: A country can use its forex reserves to finance imports, prevent bank runs, and stabilise the economy during an economic crisis.

Role of RBI in Forex Reserves

  • Custodian, Regulator and Player, Dollar/Rupee Rate, Exchange Control, stabilisation of Currency Volatility

Real Problem

  • Import/Export Policy: Depletion of forex reserves can be attributed to import licenses granted by the Ministry of Commerce, rather than RBI interventions.
  • Twin Deficits: India's trade and current account deficits need to be addressed by aligning trade control and exchange control regulations.
  • Further Depletion: India's forex reserves may decrease further due to a growing current account deficit and central bank interventions.

Government Initiatives to Boost Forex Reserves

  • Atma Nirbhar Bharat: India aims to become self-reliant, reducing the need for imports and improving forex reserves.
  • Schemes like Duty Exemption, Remission of Duty or Taxes on Export Product (RoDTEP), and Nirvik have been launched.
  • India has attracted significant Foreign Direct Investment, contributing to increased forex reserves.

Understanding the Rupee's Exchange Rate

  • The exchange rate is influenced by India's trading activities with other countries.
  • Demand for US dollars corresponds to the demand for rupees in the market.
  • A higher demand for dollars due to increased imports may lead to rupee depreciation.

Impact of Rupee's Exchange Rate

  • Weaker Rupee Benefits: A weaker rupee supports India's exporters.
  • Stronger Rupee Challenges: A stronger rupee hampers India's goal of becoming a global export hub.

Way Forward

  • Measures to Boost Forex Inflows: Increasing borrowing limits for companies, attracting deposits from NRIs, and relaxing rules for foreign investments in local-currency bonds.
  • RBI's Role in Smoothing Volatility: The RBI intervenes in the forex market to stabilize exchange rate fluctuations, ensuring credibility in India's currency.
  • Promote Export-Oriented Industries: Encouraging industries that have a competitive advantage in international markets will boost export earnings, leading to higher forex inflows.
  • Attract Foreign Direct Investment (FDI): Implement policies and reforms to attract foreign investments across various sectors, which will contribute to increased forex reserves.
  • Enhance Skill Development: Invest in skill development programs to enhance the competitiveness of the workforce, leading to higher productivity and export potential.
  • Maintain Macroeconomic Stability: Pursue prudent fiscal and monetary policies to ensure macroeconomic stability, which fosters investor confidence and attracts foreign investments.

Conclusion

Economic stability and resilience depend on forex reserves. They protect against financial crises, manage currencies, and boost market confidence. The RBI manages exchange control regulations and currency volatility and holds India's forex reserves. To avoid depletion of forex reserves, import/export policies, twin deficits, and the need for a balanced approach to trade and exchange controls must be addressed.

Samadhaan