On 4 June 2021, the Reserve Bank of India (RBI) governor, Shaktikanta Das, announced that the foreign exchange (forex) reserves in India rose to a record high of $605 billion USD. There was an increase of $6.842 billion USD, from US$598.2 billion USD recorded in the previous week. According to the Reserve Bank of India, the growth in the foreign exchange reserves was mostly due to a rise in the Foreign Currency Assets (FCA).
The forex reserves in India include Foreign Currency Assets (FCAs), gold reserves, Special Drawing Rights (SDRs) and the reserve position of the country with the International Monetary Fund (IMF). As per the weekly data released by the central bank, FCAs rose by $7.3 billion to $560. billion. Meanwhile, the gold reserves in the country declined by $502 million to $37.6 billion. The Special Drawing Rights (SDR) with the International Monetary Fund (IMF) also registered a decline of $1 million to $1.5 billion. The reserve position of India with IMF also declined by $16 million to $5 billion.
What is Foreign Exchange Reserve?
Foreign exchange reserves include all the important assets held as reserves by the central bank of a country in the form of foreign currencies. Foreign exchange reserves consist of banknotes, bonds, deposits, treasury bills and other government securities. These assets are usually kept as backup funds in case the national currency of a country devalues.
Most of the forex reserves are held in the form of U.S. dollars. This is because it is the most traded currency in the world. However, forex reserves can also comprise British pounds (GBP), the euro (EUR), the Chinese yuan (CNY) or the Japanese yen (JPY). In order to provide a barrier in case of a market shock, it is always advisable to hold forex reserves in the form of a currency that is not directly connected to the country’s own currency. With global trading, this practice has become relatively difficult as the currencies have become more intertwined.
Importance of forex reserves
The data on the forex reserve position of a country gives information about the many facets of macroeconomy including:
- the strength of the national currency
- risk-taking ability
- fund import capability
- trade contingency position
This becomes all the more significant for an import-dependent country like India. The global trade position of any country, trade surplus/deficit tendency and the current account position are all emphasised by the exchange rate position data on merchandise export. The existence of a trade deficit that exists in a country can subsequently impact the current account deficit. Forex reserves play an important role in the macroeconomic balance of a country, in case the current account deficit cannot be compensated by the inflow of foreign direct investment. In the case of unexpected economic stress, the forex reserves act as contingency funds which would help provide import support to the government.
Countries with the highest foreign reserves
Presently, China has the largest forex reserves in the world. The country with the second-largest forex reserves is Japan, which is closely followed by Switzerland, Russia and India on the International Monetary Fund table. After attaining the record high of $605 billion, India is very close to overtaking Russia to become the fourth largest country with foreign exchange reserves. According to 2020 data, the foreign exchange reserve build-up in India was recorded at 4 per cent of the GDP, which is the fourth largest after Taiwan, Hungary and the Philippines.
The forex reserve data as per the IMF report is as follows:
- China: $3,330 billion
- Japan: $1,378 billion
- Switzerland: $1,070 billion
- Russia: $605.2 billion
- India: $605 billion
The government of India has launched many schemes in the last decade which have significantly contributed to the increase in foreign exchange reserves. The most significant among them is the AatmaNirbhar Bharat scheme, which aims to reduce India’s import dependency. Other schemes include the Duty Exemption scheme, Nirvik (Niryat Rin Vikas Yojana) scheme, Remission of Duty or Taxes on Export Product (RoDTEP), and many more.
Forex trading and the importance of forex reserve data to traders
The forex trading market is where currencies of the world are traded. This market consists of a network of buyers and sellers, who exchange currency among each other at an agreed price. There is no central marketplace for this type of international market, as forex trading is mostly conducted electronically. This means that the transactions are done via computer networks between traders around the world. The currencies of the world are traded in the major financial centres of Zurich, Frankfurt, Hong Kong, London, New York, Tokyo, Singapore, Paris and Sydney.
The data on the forex reserve position of a country is important to forex traders and investors because it determines the supply and demand in the forex market. The rise in the FCA, which is largely comprised of the USD, led to the record high of forex reserves in India. The reason would have been that the USA would have poured money into Indian markets to buy Indian based goods and bonds. This would have eventually created a massive demand in the Indian market, the result of which could mean the value of USD would decrease, and the value of INR would rise. The central bank buys back the dollar to maintain the value of USD to INR, which increases India forex reserves. Forex traders and investors in the forex markets often seek CFD trading opportunities after knowing that central banks are going to buy back the USD.