Forex reserves or Foreign Exchange Reserves are assets owned by a country’s Central Bank on reserve, in terms of foreign currencies. These reserves are utilized to back liabilities of countries and play an essential factor in the fight against any crisis the country faces. Not only does it facilitate the monetary policy between the two countries but also plays a contributing part in the exports and the imports. In India, the Reserve Bank of India (RBI) holds the country’s assets.
How Foreign Exchange Reserves Work
Mainly, apart from the global trading, the assets of Forex Reserves are held significantly to ensure that a central government agency has backup funds if their national currency rapidly devalues or becomes insolvent at any point of time. The assets constitute bank deposits, bonds, banknotes, treasury bills, and various government treaties.
All over the world, the central bank of every country holds a significant amount of reserves in its foreign exchanges. The reserves are generally held in the form of U.S. dollars, which is the most commonly traded currency globally. The reason why most countries keep the Forex Reserves in the way of currencies that aren’t linked with their own currency is simply a straightforward protective measure to safeguard its assets in case of any market shock.
RBI uses the Forex Reserves to stabilize the Indian currency by selling USD in exchange for INR when depreciation of INR occurs. The amount of Forex Reserve in the country is directly proportional to the country’s trade and confidence to stabilize the economy of the country in any crisis. RBI has the supreme power to make a decision of letting the currency go down if it feels that to be the best way in moving ahead or its intervention in it will not provide any solution.
Plethora in Forex reserves provides the central bank with a cushion in alleviating the market volatility. It prevents the economic system from going into an excess trade deficit. Any country having a surplus of reserves is more stable and more comfortable economically. China holds the highest Forex Reserves in the world.
Intervention in Forex markets by RBI is crucial because of the dependency of jobs, economy, and development of the country on the policies issued by it and is, therefore, a valuable tool to safeguard against the currency volatility.
History of Forex Reserve Crisis in India
Pathetic economic policies and trade deficits of India resulted in the 1991 Indian Economic Crisis. India’s financial problem was primarily due to the extensive growth of fiscal imbalances over the 1980s. India started having problems in the “Balance of Payments” during the mid-eighties. Moreover, the imploding political system of India precipitated by the Gulf War made the situation even worse. Oil import bill swelled, exports were crashed due to several restrictions imposed in the trade, and investors took their money out. Large fiscal deficits, over time, had a spillover effect along with political crisis due to which the Indian Forex reserve was totally neglected. By the end of the 1980s, India was in serious economic troubles which started worsening over the years. The situation began to improve slowly during the early 2000s when the restrictions of trade were lifted off. Foreign investors were allowed to come to India by the Indian leaders to revive the economy of the country. Until then India was living under the delusions of East India Company and its policies. Many sectors welcomed the foreign investments and collaborations with open hands, and the economy started getting back to normal.
In the year 2010 too, India wasn’t doing well economically, but there was a peak in the Forex graph. This was because of the downfall of the rest countries due to the 2009 global financial meltdown which didn’t inflict India as much as the others. Fast forward to the year 2019, India’s reserves are rising steadily according to HSBC.
Current Scenario of India
Amidst the worldwide lockdown due to the Covid-19 pandemic, in the current scenario of the Indian economy, the economists see the graph of the Forex Reserve of India soaring high. By the month of June 2020, India’s Forex Reserves have crossed the mark of $500 billion for the first time in its history. India became the 5th largest Forex Reserve holder in the world.
One of the biggest reasons for foreign inflows’ soaring up is the accumulation of 1 lakh crore from investments of Facebook and Google on the Jio platforms in India. Foreign multi-tech companies are investing in India, and with global central banks pumping in an enormous amount of money into the global economy in low-interest rates, Indian companies are flourishing and generating funds overseas at a much cheaper cost.
“As I have been saying in recent weeks, demand suppression such as lockdown would push the INR to appreciate even more after an initial capital outflow,” said Sanjeev Sanyal, Principal Economic Advisor to the Ministry of Finance.
Another significant factor being the collapse in imports in the global economy, weakened by the COVID-19 pandemic, which has declined the rate of foreign travel along with the dollar outflow globally. Moreover, the price war between Saudi Arabia, Russia, and the United States of America made the crude oil prices fall down, thereby reducing the oil import bill significantly and saving precious foreign exchange for the country. Also, reducing the corporate tax rates the previous year has worked favourably for India in increasing its Forex reserves.
The Forex reserves currently are adequate enough to cover at least one year’s import bill for India, thereby, demonstrating the backing of domestic currency by external assets and generating confidence for markets and investors. The revival of the Indian Economy from worsening situations is indeed praise-worthy.