India’s foreign exchange reserves surpassed the $600 billion level, aided by a pandemic year in which a flood of global capital poured into emerging countries in quest of yield. As a result, most developing countries, including India, experienced an increase in foreign exchange reserves as central banks purchased dollars to prevent rapid gains in national currencies.
For the week ending June 4, 2021, India’s foreign exchange reserves increased to $605 billion, up from $598 billion the previous week. Reserves have increased by over $130 billion since March-end 2020, when the global Covid crisis intensified, leading central banks to release a wall of cash to calm economies.
While India benefited greatly from dollar flows, it was not the only one. Nonetheless, India’s reserve accumulation is among the strongest emerging countries. Reserves have increased by more than $140 billion since late 2019, ranking among the largest gains in Asia outside of Japan, according to Radhika Rao, an analyst at DBS Bank.
Even as a proportion of GDP, India’s reserve accumulation is among the greatest among emerging nations, according to Institute of International Finance statistics. India’s foreign currency reserve accumulation amounted to 4% of GDP in 2020, the most recent year for which comparable data is available. After Taiwan, Hungary, and the Philippines, this is the fourth biggest. According to Sergi Lanau, deputy head economist at the Institute of International Finance, the numbers are significant but not unusual for Asia, where many nations have traditionally carefully controlled currency rates to avoid appreciation and encourage exports.
Forex reserves and emerging economies
Most standard indicators show that reserves are more than adequate at their current levels. Given the average monthly imports in FY20 prior to the pandemic, reserves are currently sufficient for more than 15 months of imports. They are 1.1 times India’s foreign debt as of December 2020, which is $563.5 billion. The objective of reserves is to have enough to cover the budget deficit and foreign debt repayments during difficult times, according to Lanau. What is required for that is a policy choice, he says. The expense of having a lot of reserves, according to Lanau, is controlling their influence on domestic liquidity. When the RBI purchases dollars, it adds rupees to the system of Forex trading in India, which must be mopped up in order to keep money market rates near the policy rate corridor. “The RBI has done that in the (rupee) forward market, pushing rates higher and deterring companies from hedging their currency exposure,” Lanau explained. According to Madhavi Arora, head economist at Emkay Global, India is very well situated in terms of external risk when compared to developing market counterparts. However, Arora also stated that a detrimental consequence of such massive foreign reserve building has been abnormally low short-term interest rates in various periods.
Will the RBI be less active in purchasing foreign exchange now that reserves are regarded as more than adequate? DBS Bank’s Rao is not convinced. According to recent policy comments, capital buildup is a priority for the central bank, he added. “This implies that there isn’t really any barrier that they are aiming to meet, but that they regard it as important to build this buffer at least for the length of the hyper-global policies, which have turned significant inflows into rising market assets, including India.”
Gold in Forex Reserves
The significant increase in reserves due to foreign exchange inflows has meant that gold’s proportion of India’s reserves has gradually dropped. According to RBI data, gold reserves as a percentage of FX reserves have maintained between 5-7 percent since 2016. According to figures for the week ending June 4, 2021, gold accounted for 6.2 percent of total foreign reserves.
According to Bajoria, the central bank has been acquiring gold with the price increases from its current gold holdings. He explained that due to the rapid rate of money movements in the economy, the decision to allot gold is decided on a periodic rather than a regular basis. This is an asset allocation decision, he explained.
Definition of Forex reserves
A central bank’s foreign exchange reserves are assets maintained on reserve in foreign currencies. These reserves are utilized to back up claims as well as to impact monetary policy. It covers any foreign currency owned by a central bank, such as the Federal Reserve Bank of the United States.
Banknotes, deposits, bonds, treasury bills, and other government assets are examples of foreign exchange reserves. These assets are maintained for a variety of reasons, the most important of which is to ensure that a central government agency has backup funding if its national currency quickly devalues or becomes completely bankrupt.
It is standard practice for central banks throughout the world to have a large level of reserves in foreign currencies. Forex reserves usually and more generally are kept in US Dollars. The main reason behind this is that the USD is the world’s most valuable and transacted currency. Because the USD is quite a strong currency it becomes even more attractive for people who are involved in the Forex market.
According to economists, it’s always better to have a currency in reserve that isn’t linked to the domestic currency. The main reason behind this is that, if the country has an economic crisis the chances of reserved currency in foreign currency being volatile is more minimized. However, as currencies have gotten more interwoven and worldwide trade has been simpler, this technique has become more challenging.
China is the world’s biggest current foreign exchange reserve holder, with more than $3 trillion in foreign currency holdings. The majority of their reserves are stored in US dollars. One of the causes for this is that it makes international commerce easier to conduct because the majority of trading is done in US dollars.
Saudi Arabia also has significant foreign exchange reserves, as the Kingdom is primarily dependent on the export of its huge oil reserves. Their economy may suffer if oil prices continue to fall fast. They maintain significant sums of foreign cash in reserve in case this happens, even if it is simply a temporary remedy.
Russia’s foreign exchange reserves, like the other of the globe’s, are primarily stored in US dollars, although the government also retains part of its reserves in gold. Because gold is an asset with inherent assets, the danger of depending on gold in the event of a Russian economic downturn is that the value of gold will be insufficient to meet the country’s demands.
An additional disadvantage of utilizing gold as a reserve asset is that it is only worth what someone else is prepared to pay for it. During an economic downturn, this would give the company willing to buy the gold reserve the authority to determine the value of the reserve, and therefore Russia’s financial backup.