India’s foreign exchange reserves (forex reserves) touched $400 billion for the first time earlier in September. The reserves, which increased to a high of $402.51 billion in the second week of September, declined to $399.92 billion in the week ending October 20.
The reserves broadly ranged between $250 billion and $320 billion since 2009, having gathered momentum from 2013. The pace of increase in the forex reserves also coincides with Raghuram Rajan taking over as the Reserve Bank of India’s Governor. From about $275 billion in the beginning of September 2013, the reserves surged 45 per cent to the current level of $399 billion. These were the four years when the RBI went on a dollar buying spree. Data from the central bank shows that it has been purchasing, on an average, $2.5 billion every month.
In 2017, up to August, the RBI purchased $19.35 billion, more than double the $7.38 billion purchased over the same period the previous year. This was the period when the US dollar index fell sharply from around 104 to 92, down by 11.5 per cent. The RBI has utilised the weakening dollar to accumulate forex.
Reserve components
India’s forex reserve asset has four components: foreign currency, gold, reserve tranche and the special drawing rights (SDR). Foreign currency assets form the major chunk of the overall reserves, accounting for about 93 per cent, with gold coming next with a 5 per cent share. The reserve tranche and SDR, which form the remaining 2 per cent, are the assets held by the International Monetary Fund (IMF). Of these two, only the reserve tranche can be directly used by India.
As on October 20, the foreign currency assets of $374.9 billion accounted for about 94 per cent of the total reserves of $399 billion. The gold reserve is worth $21.2 billion.
Apart from these four components, the RBI’s forward contract holdings are also accounted as a forex asset. As of August, RBI held $32.82 billion in forward contract. So, including RBI’s forward position, India’s forex reserve stands at $432.8 billion ($399 plus $32.82).
Role in arresting volatility
A country’s forex reserve plays a major role in arresting abnormal volatility in the currency market. When the currency depreciates sharply in the event of any uncertainty in the market, central banks use forex reserves as a tool to stem depreciation in the domestic currency by selling the dollar.
Take, for instance, the period between May and August 2013, when the rupee tumbled from around 55 to a record low of 68.8 against the dollar. This sharp fall was caused after the US Federal Reserve announced its plan to taper the quantitative easing. In order to arrest the fall, the RBI continuously sold the dollar. It sold over $14 billion during this period.
Similarly, countries like China use their forex reserve to keep currency movement under control. China uses its whopping $3.1-trillion reserves (excluding gold) to keep the currency movement within a band on any given trading day.
Covering imports
The other important aspect of our forex reserve is its ability to cover the country’s imports, the volume of which also reflects the strength of the reserve. With about $400 billion in reserves, it can now cover 11-months of the country’s imports. Earlier, in 2013, reserves covered only about seven months of imports. The rupee strengthening from around 68 to current levels of 64 has also helped shore up the import cover.
Experts say that for an economy like India, a reserves position that covers about eight to nine months of imports is very good. So, with an ability to cover 11 months of imports, India’s forex reserve is definitely in a strong position.