Making Sense of Forex Reserves

Context: India has recently crossed a $500 Billion mark raising both pride and frustration due to the inability to understand the true nature of forex reserve in India.

Understanding forex reserve: 

• Consists of unabsorbed capital inflows: these are liabilities, that their foreign owners can take out of the country. Therefore, they are temporary.

• Acts as a source of confidence and stability: which is necessary for reassuring foreign investment in the country.

• Not a sign of great economic health: when these arise from capital inflows. Investment in the face of low absorptive capacity lead to appreciation in rupees or an increase in reserves.

Way forward: Raise the level of investment significantly above domestic savings ensuring a high rate of growth and keeping reserves and rupee in check.