EspressoLogy

At a time when the world economies are becoming more and more intertwined with each other, it becomes imperative for a country to maintain a foreign or Forex reserve.

However, it is crucial to understand what a Forex reserve is and how it works. Let's get into it.

What are Forex reserves?

Forex reserves are assets that a country's central bank holds, such as bank notes, bonds, foreign currencies, treasury bills, and government securities. For example, the Reserve Bank of India (RBI) holds dollars in its reserves. The forex reserves support its liabilities, including the native currency issued and reserves deposited by financial institutions or the government with the central bank.

What are foreign currency assets?

Foreign currency assets include:

• Banknotes
• Treasury Bills
• Deposits
• Bonds
• Government Securities

Foreign cash usually does not create any interest, whereas foreign currency assets generate income in the form of interest in foreign currency. The central bank holds these assets as a backup in case the country's currency devalues or in the case of bankruptcy.

Usually, most reserves are held in the US dollar as it is the most traded currency. However, foreign currency reserves may include currencies like Euro, British Pound, Japanese Yen, and Chinese Yuan.

Foreign currency assets consider the impact of appreciation or depreciation of non-US currencies held in foreign exchange reserves, such as the Euro, Pound, and Yen. These reserves work as a security net during extreme volatility like war, recession, and increasing dollar prices.

How are foreign reserves valued?

Foreign reserves are either in the form of the dollar, non-dollar currencies, or gold. The value of a Forex reserve is dependent upon the movements in gold prices and exchange rates.     

With this in mind, the value of the current stock of reserves also increases in response to a decline in the US dollar or a rise in gold prices. The value of the reserves' non-dollar portion decreases due to a strong dollar or a drop in gold prices.

Where India stands?

Recently, India saw the most significant jump in its forex reserves. As per RBI data, the Forex reserve rose to $531.081 billion, ending October 28, 2022. The foreign exchange reserves increased by $6,561 billion from the previous week, the most significant increase since September 2021. Every indicator of foreign exchange reserves showed growth.

Additionally, in the week ending October 28, foreign currency assets (FCA), the most significant component of reserves, increased by $5,772 billion to $470.847 billion, while gold reserves increased by $556 million to $37.762 billion.

Importance of Forex reserve

Let us now look at why Forex reserves are essential:

1. Forex reserves help governments maintain external debt obligations and foreign exchange needs.
2. In the case of an economic balance of payments crisis, growing forex reserves act as a cushion. They are sufficient to pay the nation's import expenses for an entire year.
3. A rise in forex reserves helps strengthen the rupee against the dollar.
4. Forex reserves assure markets and investors that a government can fulfil its international obligations.

Conclusion

India has the fourth largest Forex reserve in the world, with approximately 7.31% of forex reserves in gold. However, since the beginning of 2022, India's forex reserves have been under strain due to rising dollar prices and other geopolitical situations prevailing. The RBI has been taking steps to bring the problem under control.

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