India’s foreign exchange reserves, also known as forex reserves, have recently seen a significant increase in gold holdings. This rise in gold reserves follows the Reserve Bank of India’s (RBI) decision to purchase 16.58 tonnes of gold over the last six months, which raised the country’s gold holdings to more than 700 tonnes – approximately 760.42 tonnes, to be exact. This event took place during a period when Foreign Portfolio Investors (FPIs) were stepping away from India, causing a decrease in forex reserves by USD 44.73 billion.
Understanding Foreign Portfolio Investors (FPI)
Foreign portfolio investment (FPI) represents securities and other financial assets that are passively held by foreign investors. An investor does not gain direct ownership of these financial assets, and their liquidity is subject to the volatility of the market. FPI includes stocks, bonds, mutual funds, exchange-traded funds, American Depositary Receipts (ADRs), and Global Depositary Receipts (GDRs). The balance of payments (BOP) records FPI as part of a country’s capital account, measuring the amount of money flowing between countries over a fiscal year. FPI has earned the term “hot money” due to its tendency to disappear during economic instability, making it more volatile and risky than Foreign Direct Investment (FDI).
Benefits of Foreign Portfolio Investors (FPI)
There are several advantages associated with FPI, including access to international credit, improving the liquidity of domestic capital markets, and promoting the development of equity markets. Enhanced competition for financing leads to rewarding superior performance, prospects, and corporate governance. The evolution of the market’s liquidity and functionality drives market efficiency by making equity prices more value-relevant for investors.
FPI vs. FDI
Both FPI and FDI represent significant sources of funding for economies. However, Foreign Direct Investment (FDI) involves an investor purchasing a direct business interest in a foreign country, providing investors with more control over their investments. Some typical methods of making an FDI include establishing a subsidiary in another country, merging with or acquiring an existing foreign company, or forming a joint venture partnership with a foreign company.
Significance of Forex Reserves
Foreign exchange reserves comprise assets held by a central bank in foreign currencies like bonds, treasury bills, and other government securities. They provide comfort to the government and RBI when managing India’s external and internal financial issues. Increased forex reserves serve as a cushion in the event of a balance of payment (BoP) crisis, limiting external vulnerability by maintaining foreign currency liquidity. The rise in reserves strengthens the rupee against the dollar, contributes to market confidence that a country can meet its external obligations, and supports policies for monetary and exchange rate management.
Relevance in Civil Services Examination
The topic of forex reserves is notably relevant for the UPSC Civil Services Examination. In previous years, questions have revolved around what is included in India’s foreign-exchange reserves and the primary characteristic of Foreign Direct Investment (FDI) in India. These topics provide essential context for understanding India’s current economic conditions and the impact of financial regulations and practices on the country’s economy.
