India’s foreign exchange reserves have now fallen below the $600 billion mark amid capital outflows and strengthening dollar.
What are foreign exchange reserves?
Foreign exchange reserves are assets denominated in a foreign currency that are held by a central bank.
These may include foreign currencies, bonds, treasury bills, and other government securities.
These assets are held to ensure that a central government agency has backup funds if their national currency rapidly devalues or becomes all together insolvent.
It helps to check the balance payments and influences the foreign exchange rate of its currency and maintains stability in financial markets.
The two most popular foreign assets are US dollar-denominated assets and euro-denominated assets.
China is the largest foreign currency reserve holder in the world.
What about the composition of FCAs?
The FCAs comprise multi-currency assets that are held in multi-asset portfolios as per the existing norms conforming to the best international practices.
The forex reserves include
Investments on foreign securities
Investments on other central banks and the BIS
Deposits with commercial banks overseas
Gold holdings
What happened to the forex reserves of India?
The foreign exchange reserves declined from $642.45 billion (September, 2021) to $597.72 billion (April 2022).
The RBI’s special drawing rights and reserve position in the International Monetary Fund also dipped by $33 million and $26 million.
Reasons for the decline
Fall in foreign currency assets (FCAs) - The foreign currency assets also include the effect of appreciation or depreciation of non-US units like the euro, pound and yen held in the reserves.
Appreciation of the US dollar- The demand for dollars remained high as the Russia-Ukraine war led to a spike in oil and commodity prices.
Capital outflows by foreign portfolio investors (FPIs) - FPIs pulled out $21.43 billion since September 2021 as the US Federal Reserve started monetary policy tightening and interest rate hikes.
Effect of gold prices- Decline in gold prices has also played a part in the decline in foreign exchange reserves.
What is the impact on the rupee?
The rupee depreciated 57 paise and touched a low of 76.96 just below the all-time low of 76.97 to close at 76.92 against the US dollar.
If the rupee slides further, the RBI will be forced to intervene in the forex market by selling dollars from its forex reserves.
If the RBI gives preference to sustain the forex reserves level, there could be some rupee depreciation in the horizon.
