From UPSC perspective, the following things are important :
Prelims level : Forex reserves
Mains level : Balance of Payment/Trade
India’s foreign exchange reserves rose by $835 million to touch a record high of $612.73 billion in the week ended July 16, 2021, the Reserve Bank of India (RBI) data showed.
India’s forex reserves cover:
- Foreign Currency Assets (FCAs) (rose by $463 million to $568.748 billion)
- Special Drawing Rights (SDRs) (up by $1 million at $1.548 billion)
- Gold Reserves (up by $377 million to $37.333 billion)
- Reserve position with the International Monetary Fund (IMF) (up by $1 million at $1.548 billion)
(Note the descending order of the shares of various components of forex reserves. UPSC can go factual here.)
What is Foreign Exchange Reserve?
- Foreign exchange reserves are important assets held by the central bank in foreign currencies as reserves.
- They are commonly used to support the exchange rate and set monetary policy.
- In India’s case, foreign reserves include Gold, Dollars, and the IMF’s quota for Special Drawing Rights.
- Most of the reserves are usually held in US dollars, given the currency’s importance in the international financial and trading system.
- Some central banks keep reserves in Euros, British pounds, Japanese yen, or Chinese yuan, in addition to their US dollar reserves.
Countries with the highest foreign reserves
Currently, China has the largest reserves followed by Japan and Switzerland. India has overtaken Russia to become the fourth largest country with foreign exchange reserves.
- China – $3,349 Billion
- Japan – $1,376 Billion
- Switzerland – $1,074 Billion
- India – $612.73 Billion
- Russia – $597.40 Billion
Why are these reserves so important?
- All international transactions are settled in US dollars and, therefore, required to support India’s imports.
- More importantly, they need to maintain support and confidence for central bank action, whether monetary policy action or any exchange rate intervention to support the domestic currency.
- It also helps to limit any vulnerability due to sudden disturbances in foreign capital flows, which may arise during a crisis.
- Holding liquid foreign currency provides a cushion against such effects and provides confidence that there will still be enough foreign exchange to help the country with crucial imports in case of external shocks.
Initiatives taken by the government to increase forex
- To increase the foreign exchange reserves, the Government of India has taken many initiatives like AatmaNirbhar Bharat, in which India has to be made a self-reliant nation so that India does not have to import things that India can produce.
- Other than AatmaNirbhar Bharat, the government has started schemes like Duty Exemption Scheme, Remission of Duty or Taxes on Export Product (RoDTEP), Nirvik (Niryat Rin Vikas Yojana) scheme, etc.
- Apart from these schemes, India is one of the top countries that attracted the highest amount of Foreign Direct Investment, thereby improving India’s foreign exchange reserves.