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ALL ABOUT FOREX RESERVES

ALL ABOUT FOREX RESERVES

In News:

  • India’s foreign exchange reserves rose by $4.235 billion during the week ended May 8th, RBI data showed on Friday.
  • According to the RBI’s weekly statistical supplement, the overall forex reserves increased to $485.313 billion from $481.078 billion reported for the week ended May 1.

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.
  • Most foreign exchange reserves are held in U.S. dollars.
  • 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.

Types:

  • FCA:
  • Foreign Currency Assets (FCA) is the most important component of the RBI’s foreign exchange reserve.
  • They are the assets like US Treasury Bills bought by the RBI using foreign currencies.
  • The FCA is the largest component of the forex reserve.
  • Gold reserves:
  • Gold reserves are kept by Central Banks mostly for safety, liquidity, return and as a diversification strategy.
  • Special Drawing Rights:
  • The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves.
  • 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.
  • Reserve tranche:
  • The reserve tranche is a segment of an International Monetary Fund member country’s quota that is accessible without fees or economic reform conditions.
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Purpose of foreign reserves:

  • Countries use their foreign exchange reserves to keep the value of their currencies at a fixed rateA good example is China, which pegsthe value of its currency, the yuan, to the dollar. 
  • Those with a floating exchange rate system use reserves to keep the value of their currency lower than the dollar.
  • To maintain liquidityin case of an economic crisis. For example, a flood or volcano might temporarily suspend local exporters’ ability to produce goods. That cuts off their supply of foreign currency to pay for imports.
  • The central bank suppliesforeign currency to keep markets steady. It also buys the local currency to support its value and prevent inflation. This assures foreign investors. 
  • Reserves are always needed to make sure a country will meet its external obligations. These include international payment obligations, including sovereign and commercial debts. 

Source:”RBI “.

POSSIBLE UPSC CSE MAINS QUESTION:

How significant are foreign exchange reserves in stabilising the Indian economy in times of difficulty?