Context

India’s foreign exchange reserves are rising and are slated to hit the $500 billion mark soon.

About

• Forex reserves are external assets in the form 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 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.

Highlights:

• In the month of May, forex reserves jumped by $12.4 billion to an all-time high of $493.48 billion (around Rs 37.30 lakh crore) for the week ended May 29.
• The level of foreign exchange reserves has steadily increased by 8,400 per cent from $5.8 billion as of March 1991 to the current level.

Reasons behind the rise:

• Rise in investment: The major reason for the rise in forex reserves is the rise in investment in foreign portfolio investors in Indian stocks and foreign direct investments (FDIs).
• Increase in FPI: Foreign Portfolio Investments (FPIs) have now returned to the Indian markets.
• Fall in crude oil price: The fall in crude oil prices has brought down the oil import bill, saving the precious foreign exchange.

What manages the forex reserves in India?

• The Reserve Bank of India 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. 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.
• When the RBI mops up dollars, it releases an equal amount in the rupees. This excess liquidity is sterilized through issue of bonds and securities and LAF operations.

Significance of rising forex reserves:

• Helpful in managing financial issues: The rising forex reserves give a lot of comfort to the government and the Reserve Bank of India in managing India’s external and internal financial issues.
• A relief in the time of crisis: It’s a big cushion in the event of any crisis on the economic front and enough to cover the import bill of the country for a year.
• Strengthening rupee value: The rising reserves have also helped the rupee to strengthen against the dollar. The foreign exchange reserves to GDP ratio is around 15 per cent.
• Boosting confidence:  Reserves will provide a level of confidence to markets that a country can meet its external obligations, demonstrate the backing of domestic currency by external assets, assist the government in meeting its foreign exchange needs and external debt obligations and maintain a reserve for national disasters or emergencies.