Between April and December 2021, India’s foreign exchange reserves grew by US$ 63.5 billion.
Forex reserves are external assets, in the form of gold, SDRs (special drawing rights of the IMF) and foreign currency assets (capital inflows to the capital markets, FDI and external commercial borrowings) accumulated by India and controlled by the Reserve Bank of India.
The International Monetary Fund says official foreign exchange reserves are held in support of a range of objectives like supporting and maintaining confidence in the policies for monetary and exchange rate management including the capacity to intervene in support of the national or union currency.
It will also limit external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed.
How does India acquire forex?
Understanding how this happens requires understanding the functioning of India’s Balance of Payment (BoP).
The BoP details how money flows in and out of India based on millions of transactions between India and the rest of the world.
How does BoP Work?
The BoP has two accounts:
The Current Account details all exchange of money for transactions based on current consumption. It is divided into two sub-parts.
The Trade Account, which details all the exports and imports of physical goods and the Invisibles Account, which details all non-physical transactions such as services (banking, travel and tourism etc.), remittances and income from investments.
Current Account and Capital Account
The balance of payments, or BoP for short, records all the transactions, is they in goods, services or assets, of the concerned country with the rest of the world.
All such transactions over a specified time period, usually a year, are kept track of in this way.
The current account and the capital account are the two main accounts in the BoP.
Current Account:Imports and exports in goods, the trade in services and transfer payments are recorded in the current account.
Capital Account:While, all international purchases and sales of assets such as money, stocks, and bonds, etc. are recorded in the capital account. Foreign investments and loans are also included in the capital account.
What does the RBI do with the forex reserves?
The Reserve Bank functions as the custodian and manager of forex reserves, and operates within the overall policy framework agreed upon with the government.
The RBI allocates the dollars for specific purposes. For example, under the Liberalised Remittances Scheme, individuals are allowed to remit up to $250,000 every year.
The RBI uses its forex kitty for the orderly movement of the rupee. It sells the dollar when the rupee weakens and buys the dollar when the rupee strengthens.
Of late, the RBI has been buying dollars from the market to shore up the forex reserves.
When the RBI mops up dollars, it releases an equal amount in rupees. This excess liquidity is sterilised through issue of bonds and securities and LAF operations.