Context

• Unlike in 1991, when India had to pledge its gold reserves to stave off a major financial crisis, the country can now depend on its soaring foreign exchange reserves to tackle any crisis on the economic front.
• India’s foreign exchange reserves are rising and are slated to hit the $500 billion mark soon.

Why are forex reserves rising despite the slowdown in the economy?

• The major reason for the rise in forex reserves is the rise in investment in foreign portfolio investors in Indian stocks and foreign direct investments (FDIs).
• Foreign investors had acquired stakes in several Indian companies in the last two months.
• On the other hand, the fall in crude oil prices has brought down the oil import bill, saving the precious foreign exchange.
• Similarly, overseas remittances and foreign travels have fallen steeply.

What’s the significance of rising forex reserves?

• Give a lot of comfort to the government and the Reserve Bank of India in managing India’s external and internal financial issues at a time when the economic growth is set to contract by 1.5 per cent in 2020-21.
• A big cushion in the event of any crisis on the economic front and enough to cover the import bill of the country for a year.
• The rising reserves have also helped the rupee to strengthen against the dollar.
• The foreign exchange reserves to GDP ratio is around 15 per cent.
• Reserves will provide a level of confidence to markets that a country can meet its external obligations, demonstrate the backing of domestic currency by external assets, assist the government in meeting its foreign exchange needs and external debt obligations and maintain a reserve for national disasters or emergencies.

What are forex reserves?

• Forex reserves are external assets in the form gold, SDRs (special drawing rights of the IMF) and foreign currency assets (capital inflows to the capital markets, FDI and external commercial borrowings) accumulated by India and controlled by the Reserve Bank of India.
• The International Monetary Fund says official foreign exchange reserves are held in support of a range of objectives like supporting and maintaining confidence in the policies for monetary and exchange rate management including the capacity to intervene in support of the national or union currency.
• It will also limit external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed.

Where are India’s forex reserves kept?

• The RBI Act, 1934 provides the overarching legal framework for deployment of reserves in different foreign currency assets and gold within the broad parameters of currencies, instruments, issuers and counterparties.
• As much as 64 per cent of the foreign currency reserves is held in the securities like Treasury bills of foreign countries, mainly the US, 28 per cent is deposited in foreign central banks and 7.4 per cent is also deposited in commercial banks abroad, according to the RBI data.