Union Budget 2019: Foreign exchange reserves help govt influence monetary policy, act as first line of defence against economic slump

Foreign exchange reserves are assets held by the central bank of a country – the Reserve Bank in India’s case.

Healthy foreign exchange reserves help the government influence monetary policy, maintain a stable exchange rate for the domestic currency, service short-term debts, pay for essential commodities like oil and finance economic growth. Foreign exchange reserves are essentially the first line of defence against any form of an economic slowdown.

The foreign exchange reserves are generally expressed in US dollars. This is because the US dollar acts as a store of value and remains the most traded currency in the world. The reserves not only include banknotes but also deposits, bonds, treasury bills and other government securities.

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The foreign exchange reserves are held in four major categories by the government: foreign currency assets, gold, special drawing rights (SDR), and reserve position in the International Monetary Fund (IMF).

Representational image. News 18.

Foreign currency assets, expressed in US dollars, include the effect of appreciation or depreciation of non-US currencies like the euro, pound and yen held in the reserves. Assets like US Treasury Bills bought using foreign currencies are also part of it. Foreign currency assets are the single biggest component of forex reserves.

Gold reserves are also an important component of the reserves – the second largest contributor after foreign currency assets.

The SDRs are an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. According to the IMF, the value of the SDR is based on a basket of five currencies — the US dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling.

Reserve position in the IMF refers to an arrangement where member nations need to deposit certain quota of currency with the IMF. This quota can be utilised by a member state at any point of time without a service fee.

India and world’s position

India’s foreign exchange reserves increased by $1.686 billion to $423.554 billion for the week ending on 7 June. As per the RBI’s latest data, foreign currency assets rose by $1.666 billion to reach $395.801 billion. Meanwhile, gold reserves were unchanged at $22.958 billion. The SDRs with the IMF rose $6.1 million to $1.449 billion. The country's reserve position with the IMF also rose $14 million to $3.3345 billion.

While India’s total foreign exchange reserves find a place in the top 10 nowadays, the situation was grim in 1991. That year, India faced a serious balance of payment crisis as the government only had $5.8 billion of foreign exchange, which could barely finance imports for three weeks. The lack of foreign exchange reserves meant India had to ship its gold reserves to raise money for paying the import bill.

Eventually, as is known to everyone, India eventually introduced liberal economic reforms, which not only helped the country achieve a higher growth trajectory but also improve its forex reserves. In fact, by March 1995, India’s forex reserves had risen to $25.2 billion.

Internationally, China holds the biggest foreign exchange reserves in the world, worth a whopping $3 trillion. China holds most of its assets in US dollars since it makes international trade easier to execute as most of the trading takes place using US dollar.

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