India's Rising Forex Reserves!

India’s Rising Forex Reserves

India’s forex reserves have been making it to headlines regularly for the past few months, as its forex reserves cross $ 500 billion.

Why is it so special?

What are forex reserves?

What is its importance?

Why are they rising even after the slowdown in the economy?

We’ll be discussing all of it here!!

The economy is under stress, we all have seen a massive plunge in the GDP but rising forex reserves have come as a breather during these harsh times as it can cover India’s import bill for more than a year.

 What are forex reserves?

As per IMF, external assets that a country’s monetary authority can use to meet the balance of payment financing needs.

Forex reserves have 4 components:

1. Foreign Currency Assets

2. SDR (Special Drawing Rights)

3. Gold

4. RTP (Reverse Tranche Position)

 Now, in India’s case Forex reserves have risen to a whole new level, but why?

The rise in the forex reserves of India are a consequence of various factors, i.e.

1. The sharp rise in FPI inflows: There has been a huge influx of FPI following the government’s decision in Sep 2019 to cut corporate tax rates.

2. FDI inflows: There has been an increase in the FDI inflow and we all know that the Jio platform is one of the major reasons here contributing around 1 lakh crores to FDI.

3. Crude Oil prices: In Jan 2020, oil was at $60-70 per barrel which fell to the levels of $20 per barrels towards March-end leading to it trading at $9 to $20 in April. Crude oil contributes to 20% of India’s import bill and lockdown led to a fall in imports as well which further reduced India’s import bill.

4. Dip in Gold imports: Gold is also one of the major components of imports and there has been a sharp decline in the quarter ended in June 2020 following the high prices and lockdown induced by the COVID-19 pandemic. World Gold Council (WGC) also stated that Gold imports declined by 95% to 11.6 tonnes in the quarter as compared to 247.4 tonnes in the same period a year ago due to poor demand.

5. Savings on import bill: COVID-19 has drastically impacted global trade. There has been a sharp decline in the import expenditure for items like electronics, gold, crude oil, etc.

6. Fall in Foreign travel: Worldwide lockdown amid the pandemic has led to a fall in foreign travel, which has consequently reduced the use of foreign currency.

Alright, there has been a rise in forex reserves but what benefit it is going to provide?

So, forex reserves provide comfort to the government and RBI in managing India’s external and internal financial issues at a time when economic growth has plunged.

These rising forex reserves can provide a cushion in the event of any crisis on the economic front.

We all know how the rupee was continuously depreciating and these reserves helped RBI to release dollars into the market and mopping up the rupee which helped the rupee to strengthen i.e., in a way RBI did not let the rupee to be volatile amid the coronavirus crisis.

The risen level of forex has increased our forex to GDP ratio to 15%.

Added to all of this, higher forex reserves provide a level of confidence to markets that a country can meet its external obligations, which in turn will again help in FPI inflows.

Now the question arises, what does RBI do with these reserves?

Where are they kept?

RBI functions as a custodian of these reserves and allocate it to various purposes.

Many schemes, controlling the volatility of the rupee, import bills, etc. require forex reserves.

64% of the foreign currency reserves are held in securities like T-bills of foreign countries mainly the US, whereas 28% is deposited in foreign central banks and around 7.4% is also deposited in commercial banks abroad as per RBI.

 Coronavirus has surely led to some of the unexpected events, rise in forex reserves is one of them. Although forex reserves provide a cushion to the government and RBI amid this crisis, we are yet to see how the government and RBI fight this crisis now that our GDP has plunged by 23.9%.