The latest numbers released by the Reserve Bank of India (RBI) show a reduction in the country’s foreign exchange (forex) reserves. As per the RBI data, the forex reserves dipped by $2.986 billion marking a decrease to $579.285 billion as of the week ending on 26th March 2021. This decrease is mainly driven by declines in the Special Drawing Rights (SDR), the Foreign Currency Assets (FCA) and the Reserve Position, while gold reserve component witnessed an increase.
Understanding Foreign Exchange Reserves
Foreign exchange reserves encompass assets that a central bank holds in currencies other than its own, typically including bonds, treasury bills and government securities. A crucial point worth noting here is that a majority of these reserves are maintained in US dollars.
The Purpose Behind Holding Forex Reserves
Forex reserves play an essential role in supporting and instilling confidence in monetary and exchange rate management strategies. They also provide the capacity for intervention to uphold the national or union currency. Furthermore, maintaining foreign currency liquidity aids in limiting external vulnerability by absorbing shock during times of crisis or restricted access to borrowing.
Composition of India’s Forex Reserves
India’s forex reserves comprise of four major components: Foreign Currency Assets (FCAs), Gold reserves, Special Drawing Rights (SDRs) and the Reserve Position with the International Monetary Fund (IMF).
About Foreign Currency Assets
Foreign Currency Assets, also known as FCAs, are assets valued in a currency other than India’s own currency. FCA is the most substantial component of the country’s forex reserve and is accounted for in dollar terms. These assets include the impacts of appreciation or depreciation of non-US units such as the euro, pound and yen held within the forex reserves.
The Role of Gold Reserves
Gold reserves play a unique role within the foreign reserves of central banks. They are often held for diversification purposes. Moreover, the credibility of a central bank is often associated with holding adequate gold reserves. Gold’s high-quality and liquidity enable Central Banks to preserve capital, diversify portfolios, reduce risks over the medium to long term. Historical data have demonstrated the consistently higher average returns on gold compared to other alternative financial assets.
Understanding Special Drawing Rights
The Special Drawing Rights (SDRs) is an international reserve asset, introduced by the International Monetary Fund (IMF) in 1969. It aims to supplement the official reserves of its member countries. SDRs, which are neither a currency nor a claim on the IMF, represent a potential claim on the freely usable currencies of IMF members. The value of the SDR is derived from a weighted basket of major currencies, including the US dollar, the euro, Japanese yen, Chinese yuan, and British pound. Interest paid to members on their SDR holdings is referred to as SDR interest rate or SDRi.
Reserve Position in the International Monetary Fund
The Reserve Position in the International Monetary Fund signifies the portion of the required quota of currency that each member country provides to the IMF that it can utilize for its own needs. This reserve tranche essentially serves as an emergency fund that IMF members can access at any time without having to agree to conditions or pay a service fee.
