Economic Indicators and Various Reports On It- GDP, FD, EODB, WIR etc

What explains the new mark crosses by our Forex reserves

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Forex reserves and exchange rates

Mains level : Paper 3- India's Forex reserves touched ceiling of half-trillion

At first, it seems almost contradictory. And so it is. Our foreign exchange reserves touched new high of $500 billion for the first time, but the time in which this has happened makes it paradoxical. At the time when economies around the world are touching new lows, this rise in the Forex seems all but usual. In this article, you’ll learn about the 4 factors that made it happen.

1. Decreased oil imports

  • Usually, we import a lot of oil.
  • But the payment here is dollar-denominated since very few countries are going to accept our currency (Rupee) as is.
  • So, you have to expend dollars i.e. the foreign exchange reserves to keep the flow of crude oil intact.
  • However, with the nationwide lockdown in place, our import bill has reduced drastically.
  • We simply don’t need as much oil anymore.
  • And considering oil prices have also taken a beating simultaneously, our Forex Reserves have been piling up.
  • Less oil import. More Forex reserves.

2. Dollars coming with foreign investors

  • Contrary to popular opinion, foreign investors have been pouring money into India of late.
  • You could attribute a bulk of these inflows to Reliance Jio.
  • They’ve been enticing investors all over the world and they’ve been doing it at a pace that belies all rational expectations.
  • They’ve raised close to $15 Bn over the course of a few months and it doesn’t look like they’re stopping anytime soon.
  • So technically, dollar inflows have spiked and therefore, Forex reserves get a boost once again.

3. RBI preparing itself for a bad time

  • Another popular explanation is that the RBI is preparing a war chest to stave off future uncertainties.
  • At a time when the world economy is reeling from an unprecedented crisis, it’s perhaps prudent to build up reserves for a rainy day.
  • So the RBI buys gold and dollar-denominated assets using our national currency and builds up the foreign exchange reserves.
  • Inadvertently, this increases the money supply within the economy.
  • There will be more “Rupees” floating around.
  • As more Indian currency keeps entering the ecosystem, the value of the rupee depreciates.
  • And yes, the value of rupee has tumbled recently, but we are not in dire straits yet.
  • But if India’s economy takes a turn for the worse, it becomes incumbent on the RBI to ensure price stability.
  • Imagine the value of the rupee starts fluctuating wildly because of economic uncertainties.
  • The RBI has to intervene.
  • It has to exchange the foreign reserves for the Indian currency.
  • If they keep mopping up the excess Rupees floating in the system, they could ensure the value of the rupee remains stable.
  • So long as the value of the rupee remains stable, prices of commodities will follow the same cue, all things remaining equal that is.
  • Now, there’s still no clear consensus on what kind of reserves we might need if things do go south.
  • Although there have been recommendations made in the past about hoarding too much, it’s still the RBI’s call at the end of the day.

4. The RBI is doing it for the government

  • The RBI can turn a profit if it wants to.
  • And once it does turn a profit, it can transfer a part of the surplus to the government — as dividends.
  • Now if the RBI wanted to offer the government a higher dividend, it has to simply turn a higher profit.
  • One way to accomplish this is to simply let the value of the rupee depreciate. Do not intervene.
  • Do not forego the reserves. Let the rupee tumble.
  • And so long as you don’t intervene, all the dollar-denominated assets you own will be worth more in rupee terms.
  • Consider the hypothetical example-suppose the exchange rate was 1$= Rs. 71 in March 2020, then the rupee loses value and you see the same line item once again in June 2020 will be 1$=Rs. 76.
  • The extra ₹ 5 is treated as a profit. And this profit could be ploughed back to the government.

Consider the question “With the economy in the tailspin amid pandemic, the news of India’s Forex reserves touching the $500 billion mark for the first time provided the semblance of solace. Examine the factors that could explain this increase.”

Conclusion

Though there will always be the debate over the optimum value of the Forex reserves, the new level it reached in such an uncertain time for the economy is, nonetheless, a cause for celebration.

 


Reference Source : https://finshots.in/archive/india-foreign-exchange-reserves/

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