India’s foreign exchange reserves explained: what they are, who holds them and how RBI uses them

Competitive Exam Explainers | Indian economy

Why in the news?

India’s foreign exchange reserves rose from $7.26 billion to $674.193 billion in the week ended July 3, the Reserve Bank of India said on Friday. The previous week, the currency kitty had fallen by $5.654 billion to $666.933 billion. The kitty had expanded to an all-time high of $728.494 billion in the week ending February 27 this year before the start of the Middle East conflict, which led to a multi-week slide as the rupee came under pressure and the RBI had to intervene in the foreign exchange market through sales in dollars. prime minister Narendra Modi he has also made multiple public appeals since May 11 to his countrymen to save foreign exchange by reducing foreign travel, limiting fuel use and refraining from buying gold for a year.In this context, let’s understand what foreign reserves actually are, who holds them and when the RBI can dip into them.

The concept in simple terms

Foreign exchange reserves are the stock of foreign currency, gold and other international assets that a country’s central bank holds to meet external payment obligations and to keep the domestic currency stable. Think of them as a nation’s emergency foreign currency fund, used to pay for imports, service foreign debt and defend the rupee if it comes under pressure.A common misconception is that these reserves are simply idle “government money.” The RBI actually creates these reserves by buying foreign currency in the market with newly created rupees. So while reserves are a national asset, they also face a rupee liability on the RBI’s own balance sheet. This is why the RBI, not the finance ministry, decides how and when the reserves are deployed, and why they cannot simply be transferred to the government to fund the budget.

how it works

India’s foreign exchange reserves have four components:

The RBI accumulates these assets through market intervention (buying dollars when there is excess inflow), interest income from existing reserves and financing from multilateral bodies. It draws them mainly to sell dollars when the rupee depreciates sharply, smoothing volatility rather than defending a fixed target.

Key institutions and legal framework

context of India

India has among the world’s largest reserves, placing it well behind China, but among the world’s top holders, giving it comfortable import coverage. Meanwhile, the RBI’s revised FCNR-B deposit scheme is expected to attract $40-50 billion in new deposits, with banks stepping up their focus on NRI customers. The banking sector has so far mobilized between $3 billion and $4 billion through FCNR-B deposits. This scheme, aimed at non-resident Indians, is one of the tools the RBI is using to rebuild reserves after the fall caused by the Middle East conflict and related pressure on the rupee. Historically, reserves have played a decisive role in past crises, most notably in 1991, when India had to pledge gold for emergency loans, and in 2008, when reserves cushioned the global financial crisis without the need for an IMF bailout. FACTBOX

Main Practice Questions: “Foreign reserves are a national asset but also a central bank liability.” Discuss this statement with reference to the composition and management of India’s foreign exchange reserves and examine the limits of their use for fiscal purposes.

Put yourself to the test

Q1. Which of the following are components of India’s foreign exchange reserves?

Select the correct answer:(a) 1, 2 and 3 only(b) 1 and 4 only(c) 2 and 3 only(d) 1, 2, 3 and 4Answer: (a)P2. The reserve section position refers to:(a) India’s gold holdings with the World Bank(b) The part of India’s IMF Quota accessible without conditions(c) A loan contracted by India from the IMF(d) India’s foreign debt to other nationsAnswer: (b)P3. What law currently governs foreign exchange transactions in India?(a) FERA, 1973(b) RBI Act, 1934(c) FEMA, 1999(d) Banking Regulation Act of 1949Answer: (c)Q4. The largest component of India’s foreign exchange reserves by value is:(a) Or(b) Special drawing rights(c) Foreign currency assets(d) Reserve Tranche PositionAnswer: (c)Q5. The RBI mainly uses foreign reserves to:(a) Fund the union budget directly(b) Intervene in the foreign exchange market and stabilize the rupeec) Pay the salaries of public employees(d) Fund state government plansAnswer: (b)

Essential terms