Decline in Forex Reserves

• 05 Apr 2021

Why in News

According to the recent data from the Reserve Bank of India (RBI), India’s Foreign Exchange (Forex) reserves declined by USD 2.986 billion to reach USD 579.285 billion in the week ended 26^th March 2021.

• The gold reserve component of the Forex Reserve increased whereas the other components - Special Drawing Rights (SDR), the Foreign Currency Assets (FCA) and the Reserve Position witnessed decline.

Key Points

• About:
  
  • Foreign exchange reserves are assets held on reserve by a central bank in foreign currencies, which can include bonds, treasury bills and other government securities.
    
    • It needs to be noted that most foreign exchange reserves are held in US dollars.
• Objectives Behind Holding Forex Reserves:
  
  • Supporting and maintaining confidence in the policies for monetary and exchange rate management.
  • Provides the capacity to intervene in support of the national or union currency.
  • Limits external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed.
• India’s Forex Reserve include:
  
  • Foreign Currency Assets
  • Gold reserves
  • Special Drawing Rights
  • Reserve position with the IMF
• Foreign Currency Assets:
  
  • FCAs are assets that are valued based on a currency other than the country's own currency.
  • FCA is the largest component of the forex reserve. It is expressed in dollar terms.
  • The FCAs include the effect of appreciation or depreciation of non-US units like the euro, pound and yen held in the foreign exchange reserves.
• Gold Reserves:
  
  • Gold occupies a special position in the foreign reserves of central banks as it is widely stated to be held for reasons of diversification.
  • Moreover, the unique property of gold is believed to be its ability to enhance the credibility of the central bank when it holds adequately and this has been proved time and again.
  • Gold compares extremely favorably to other traditional reserve assets with high-quality and liquidity helping Central Banks to preserve capital, diversify portfolios, mitigate risks on the medium/long-term.
    
    • Gold has consistently outperformed the average returns of other alternative financial assets.
• Special Drawing Rights:
  
  • The SDR is an international reserve asset, created by the International Monetary Fund (IMF) in 1969 to supplement its member countries’ official reserves.
  • The SDR is neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. SDRs can be exchanged for these currencies.
  • The value of the SDR is calculated from a weighted basket of major currencies, including the US dollar, the euro, Japanese yen, Chinese yuan, and British pound.
  • The interest rate on SDRs or (SDRi) is the interest paid to members on their SDR holdings.
• Reserve Position in the International Monetary Fund:
  
  • A reserve tranche position implies a portion of the required quota of currency each member country must provide to the IMF that can be utilized for its own purposes.
  • The reserve tranche is basically an emergency account that IMF members can access at any time without agreeing to conditions or paying a service fee.

Source: IE