Context

The Reserve Bank of India released its bi-annual report on management of foreign exchange reserves.

About

• Reserve Bank of India’s (RBI) bi-annual report on management of foreign exchange (forex) reserves is part of its efforts towards enhanced transparency and levels of disclosure.
• Findings of the report:
  • India's forex reserves for the week ended 13 December stood at $454.492 billion on account of increase in foreign currency assets (FCA).
  • India's forex reserves increased by 5% during the second half of the financial year ended September 2019 (H2FY20).
  • As at end-September, 2019, the Reserve Bank held17 tonnes of gold, with 325.87 tonnes being held overseas in safe custody with the Bank of England and the Bank for International Settlements, while the remaining gold is held domestically.
  • The foreign exchange reserves cover of imports stood at 10 months.
  • The ratio of short term debt to reserves which was 26.3% at the end of March 2019 declined to 25.5% at the end of June 2019.
  • In dollar terms, the share of gold in total foreign exchange reserve increased to 6.1% at the end of September from 5.6% as of March 30.

Objectives of forex reserve management

• Demands placed on foreign exchange reserves may vary widely depending upon a variety of factors including;
  • Exchange rate regime adopted by the country
  • Extent of openness of the economy
  • Size of the external sector in a country's GDP
  • Nature of markets operating in the country.

Legal Framework and Policies

The Reserve Bank of India Act, 1934 provides the overarching legal framework for deployment of reserves in different FCA and gold within the broad parameters of; currencies, instruments, issuers and counterparties. The law broadly permits the following investment categories:

• • Deposits with other central banks and the Bank for International Settlements (BIS).
  • Deposits with overseas branches of commercial banks.
  • Debt instruments representing sovereign/sovereign-guaranteed liability with residual maturity for debt papers not exceeding 10 years.
  • Other instruments/institutions as approved by the Central Board of RBI in accordance with provisions of the Act.
  • Dealing in certain types of derivatives.

Terms related to Foreign exchange

• Foreign Currency Assets(FCA): FCA are maintained as a multi-currency portfolio comprising of major currencies, such as, US dollar, Euro, Pound sterling, Japanese yen, etc. and are valued in terms of US dollars. FCA excludes:
  • Investment in bonds issued by India Infrastructure Finance Company (UK)
  • SDR holdings of Reserve Bank, which is included under SDR
  • Amount lent under SAARC Swap Arrangement.
• Currency Risk: Currency risk arises due to movements in exchange rates. Forex reserve related decisions are taken on account of long-term exposure to different currencies, depending on their likely movements and other considerations in the medium and long-term.
• Special Drawing Rights (SDR): An SDR is an artificial currency instrument created by the IMF in 1969 to supplement the existing money reserves of member countries. It was created in response to concerns about the limitations of gold and dollars as sole means of settling international accounts; SDRs augment international liquidity by supplementing the standard reserve currencies. The IMF uses SDRs for internal accounting purposes. SDRs are allocated by the IMF to its member countries and are backed by their full faith and credit. SDR is built from a basket of important national currencies.
  • US dollar
  • Euro
  • Chinese Yuan
  • Japanese Yen
  • Pond Sterling
• Reserve Tranche Position (RTP): The IMF is funded through its members and their quota contributions. A reserve tranche is a portion of the required quota of currency each member country must provide to the International Monetary Fund (IMF) that can be utilized for its own purposes—without a service fee or economic reform conditions.
  • It is basically an emergency account that IMF members can access at any time without agreeing to conditions or paying a service fee.
• SAARC Swap Arrangement: A currency swap between the two countries is an agreement or contract to exchange currencies with predetermined terms and conditions. SAARC swap Arrangement entails currency swap between the SAARC countries. It is mostly done to meet short term foreign exchange liquidity requirements or to ensure adequate foreign currency to avoid Balance of Payments (BOP) crisis. SAARC swap Arrangement framework includes:
  • RBI will offer swap arrangement within the overall corpus of USD 2 billion.
  • Swap withdrawals can be made in US dollar, Euro or Indian rupee.
  • The framework provides certain concessions for swap withdrawals in Indian rupee.
  • The facility will be available to all SAARC member countries, subject to their signing of bilateral swap agreements.
  • The particular framework is valid from 14th November, 2019 to 13th November, 2022.