Foreign Exchange Reserves

Notes

Foreign exchange reserves are the foreign assets held by a country's central bank (RBI in India). The components are:

Foreign currency assets (FCA): the largest part (about 85-90%), mainly US Treasuries and deposits; valuation changes in the dollar, euro and yen affect it.
Gold.
Special Drawing Rights (SDRs), the IMF's reserve asset (a basket of the US dollar, euro, Chinese yuan (added in 2016), Japanese yen and pound sterling).
Reserve Tranche Position (RTP) in the IMF.

Position: India's reserves rose from about US$1.2 billion in 1991 to a peak of over US$700 billion in 2024. India is among the top five holders globally (with China, Japan and Switzerland). The RBI publishes the data weekly (the Weekly Statistical Supplement). In 2024 the RBI brought a large part of its gold back from the UK to India.

Adequacy measures

Import cover (the traditional benchmark is about three months; the 1993 Rangarajan Committee report on BoP suggested this); India's cover is about 10-11 months.
Reserves to short-term external debt (Greenspan-Guidotti rule: reserves should at least equal short-term debt), reserves to GDP (about 17-18%), and reserves to external debt (about 95% or more).

Sources: capital inflows (FDI and FPI), current account surpluses (rare), RBI purchases of dollars, and valuation gains.

Uses: to defend the rupee from sharp falls (by selling dollars), pay for imports, service external debt and maintain confidence and credit ratings during crises.

Costs: the opportunity cost (low returns on safe assets), the cost of sterilisation (such as the MSS) of the rupee liquidity created by dollar purchases, and exposure to valuation risk.

Key Points

Reserves: FCA (largest), gold, SDRs, reserve tranche in the IMF.
1991: about US$1.2 billion; peak over US$700 billion (2024).
Adequacy: import cover (about 10-11 months), cover of short-term external debt.
Used to defend the rupee and ensure confidence.
Costs: low returns and sterilisation.

MCQs

Q1. The largest component of India's foreign exchange reserves is: (a) Gold (b) Foreign currency assets (c) SDRs (d) Reserve tranche position Ans: (b).

Q2. The SDR basket does NOT include the: (a) US dollar (b) Chinese yuan (c) Indian rupee (d) Japanese yen Ans: (c).

Q3. The "import cover" measures: (a) The number of months of imports that reserves can finance (b) The ratio of imports to GDP (c) The tariff on imports (d) The share of oil in imports Ans: (a).