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April 04, 2017 @ 01:15 PM

Forex Reserves and Their Benefits

Published : Monday, 14 December, 2015 9:05 AM

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Forex Reserves and Their Benefits

For anything to qualify as money, it must possess three important characteristics - the store of value, medium of exchange and general acceptability. Since a 100 Rupee note has a value equivalent to Rupee 100 and is generally acceptable as the medium of exchange, it is money in India. Similarly if a blank cheque fulfils all three characteristics, it is also considered as money. However, Iran may not accept the Indian Rupee as a mode of payment for Indian oil imports and therefore Rupee doesn’t qualify as international currency. Since the hard currencies like US dollar, or the gold or Special Drawing Rights (SDR) of International Monetary Fund (IMF) serves all three purposes of money in the international market, they are acceptable in international transactions. In order to pay for its import bills, almost every country maintains a reserve of foreign exchange (forex).

Indian Forex Reserves

The Reserve Bank of India (RBI) is the custodian and manager of Indian forex reserves. According to the RBI data, as on December 4, 2015, the accumulated forex reserves in India were to the tune of USD 352 billion (INR 23,415 billion) which included USD 329 billion foreign currency assets, USD 17 billion worth of gold, USD 4.0 billion worth of SDRs and USD 1.2 billion reserve position with IMF.

For any developing country, what should be the adequate level of forex reserves is a very subjective question. Around two decades back, the forex reserve which could finance the imports of three to six months was considered adequate but the change in global trade and finance patterns have changed the adequacy norms for forex reserves. Now the adequacy norms not only covers import bill but also factors in percentage of reserves to short-term debt, as a proportion of external debt, ratio of reserves to GDP, as percentage of current account deficit (CAD) and inflow and outflow variations from the capital account. Judging by any factor, the forex reserves in India are currently more than sufficient.

Advantages of Forex Reserves

  • The foremost advantage of the forex serves is in meeting the international finance obligations including sovereign and commercial debts, financing of imports.
  • It helps in boosting the confidence of the market in the ability of a country to meet its external obligations.
  • It acts as cushion for unforeseen external shocks. It was due the adequate forex reserve level that India was able to bear the global meltdown of 2008.  
  • Increases confidence of foreign investors and thus helps in boosting foreign direct investment (FDI).
  • RBI uses the forex reserves to adjust foreign exchange rate. In case of sharp fall in the foreign exchange value of the Rupee, RBI sells the Dollar which appreciates the Rupee.
  • The foreign currency assets are invested mainly in instruments abroad which have the highest credit rating and which do not pose any credit risk. These include sovereign bonds, treasury bills and short-term deposits in top-rated global banks besides cash accounts.

Because of the aforesaid reasons, almost all countries particularly developed hold high level of foreign exchange reserves despite the high cost of holding it.

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