Why Indian Forex Reserves Are Rising?

Forex reserve of India may be going to hit the $500 billion mark by the end of June. Recently, forex reserves jumped by $14.4 billion and reached to its all time high of $493.48 billion in the month of May.

What is forex reserve?

Forex reserves‘ are also known as foreign exchange reserve, foreign reserve, foreign currency assets and international reserve. Forex reserves are foreign currencies which are hold by a country’s government or central bank. In forex reserve, governments try to hold reserves of valuable currencies, such as the dollar, euro, Swiss franc, or pound. Foreign reserves may also include treasury bills, bonds, bank deposits, banknotes, and other government securities.

Why forex reserves are rising despite the slowdown in the Indian economy?

Major reasons for the rise in forex reserves are:-

  • Recently, foreign investors are investing in the Indian market through foreign direct investment (FDI) and foreign portfolio investment (FPI). Reliance subsidiary Jio recently received $5.7 billion from Facebook and the many more series of investments are also about to come.
  • On the other hand, the fall of the price of crude oil has also played an important role in the rise of forex reserves, and in recent times, due to COVID-19 imports are also partially stoped. This phenomenon has played the main role in the rise of the forex reserve.

So the major reasons behind the rise in the forex reserve are market sentiments and natural disaster. Clearly this can be seen that the present forex reserves are not rising due to economic rise.

What’s the importance of rising forex reserves?

The forex reserves enable the government and the Reserve Bank of India in managing India’s external and internal financial issues. The rising and robust Forex Reserve holds strategic significance at a time when the economic growth is set to contract due to prolonged slow down and the entire economy is battered by Covid-19. It is estimated that the Indian economy would contract by 1.5 percent in 2020-21. A healthy Forex Reserve provides a big cushion in the time of any crisis on the economic front and largely it can cover the import bill of the country. The rising reserves show that the inflow of foreign currencies is more than the outflow and it also helps the rupee to strengthen against the dollar. At present, the foreign exchange reserves to GDP ratio tilts around 15 percent. It will provide a level of confidence to markets by underscoring the sovereign solvency factor that a country can meet its external obligations, demonstrate the backing of domestic currency by external assets, assist the government in meeting its foreign exchange needs and external debt obligations and maintain a reserve for national disasters or emergencies.

What does the RBI do with the forex reserves?

The RBI works as the custodian and manager of forex reserves. The RBI allocates the dollars for specific purposes. For example, under the Liberalised Remittances Scheme, individuals are allowed to remit up to $250,000 every year. The RBI uses its forex kitty for the orderly movement of the rupee. It sells the dollar when the rupee weakens and buys the dollar when the rupee strengthens. Of late, the RBI has been buying dollars from the market to shore up the forex reserves. When the RBI mops up dollars, it releases an equal amount in the rupees. This excess liquidity is sterilized through issue of bonds and securities and LAF operations. “Despite the global dollar weakness, the RBI does not seem to be keen to step off the gas as far as reserve accumulation is concerned… the sentiment in the rupee has been skewed by incessant dollar purchases by the central bank to strengthen its balance sheet,” said Abhishek Goenka, CEO, IFA Global.

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