Q. Which one of the following groups of items is included in India’s foreign-exchange reserves?

  • Foreign-currency assets, Special Drawing Rights (SDRs) and loans from foreign countries
  • Foreign-currency assets, gold holdings of the RBI and SDRs
  • Foreign-currency assets, loans from the World Bank and SDRs
  • Foreign-currency assets, gold holdings of the RBI and loans from the World Bank

Answer: (b) Foreign-currency assets, gold holdings of the RBI and SDRs

Foreign Exchange Reserves:
  • Foreign Exchange Reserves (also called Forex Reserves) are reserve assets held by a central bank in foreign currencies.
  • These may include foreign currencies, bonds, treasury bills, and other government securities.
  • Reserves are denominated and expressed in the US dollar, which is the international numeraire for the purpose.
  • RBI is the custodian of the Foreign exchange reserves in India.
  • India’s foreign exchange reserves comprise of;
    • Foreign currency assets (FCAs):These are maintained in currencies like the US dollar, euro, pound sterling, Australian dollar and Japanese yen.
    • Gold
    • SDR (Special Drawing Rights): This is the reserve currency with IMF.
    • RTP (Reserve Tranche Position): This is the reserve capital with IMF.
  • The biggest contributor to India’s Forex reserves is foreign currency assets, followed by gold.
  • Purpose:
    • They are used to back liabilities on their own issued currency, support the exchange rate and set monetary policy.
    • To ensure that RBI has backup funds if their national currency rapidly devalues or becomes altogether insolvent.
    • If the value of the Rupee decreases due to an increase in the demand of the foreign currency, then RBI sells the dollar in the Indian money market so that depreciation of the Indian currency can be checked.
    • A country with a good stock of forex has a good image at the international level because the trading countries can be sure about their payments.
    • A good forex reserve helps in attracting foreign trade and earns a good reputation with trading partners.
  • Significance of Rising Forex Reserves:
    • Comfortable Position for the Government: The rising forex reserves give comfort to the government and the RBI in managing India’s external and internal financial issues.
    • Managing Crisis: It serves as a cushion in the event of a Balance of Payment (BoP) crisis on the economic front.
    • Rupee Appreciation: The rising reserves have also helped the rupee to strengthen against the dollar.
    • Confidence in Market: Reserves will provide a level of confidence to markets and investors that a country can meet its external obligations.

Foreign Currency Assets

  • FCAs are assets that are valued based on a currency other than the country’s own currency.
  • FCA is the largest component of the forex reserve. It is expressed in dollar terms.
  • The FCAs include the effect of appreciation or depreciation of non-US units like the euro, pound and yen held in the foreign exchange reserves.

Special Drawing Rights

  • The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves.
  • The SDR is neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. SDRs can be exchanged for these currencies.
  • The value of the SDR is calculated from a weighted basket of major currencies, including the US dollar, the euro, Japanese yen, Chinese yuan, and British pound.
  • The interest rate on SDRs or (SDRi) is the interest paid to members on their SDR holdings.

Reserve Position in the International Monetary Fund

  • A reserve tranche position implies a portion of the required quota of currency each member country must provide to the IMF that can be utilized for its own purposes.
  • The reserve tranche is basically an emergency account that IMF members can access at any time without agreeing to conditions or paying a service fee.