Forex Reserves & Rupee’s Exchange Rate

In News

• Recently, India’s foreign exchange reserves fell to their lowest level in over 14 months as the central bank sold dollars to prop up the currency.  

About the recent data

• The reserves fell $5.01 billion to $588.3 billion.
  • The decline in the reserve comes amid the rupee hitting record lows.
• Reasons:
  • The central bank has been selling dollars to curb excessive volatility in the exchange rate and prevent runaway depreciation in the rupee.
  • In 2022 overseas investors had net sold $30.29 billion worth of Indian assets.
• India’s trade deficit too is a record monthly high of $25.63 billion last month.
• The country which has the highest forex reserves in the world is China.
  • Because it wants its exports to be attractive in the global market.

What are Forex reserves? 

• It is regarded as the health meter of a country.
• These reserves are assets like foreign currencies, gold reserves, and treasury bills, among other things, maintained by a country’s central bank which checks the balance of payments, deals with the foreign exchange rate of currency and maintains financial market stability.
• RBI Act and the Foreign Exchange Management Act, 1999 govern the foreign exchange reserves.
• It can be broken into four categories:
  • The first and largest component is foreign currency assets; it constitutes about 80% of the total portfolio.
  • Investment in gold.
  • Special drawing rights from the IMF.
  • Reserve Tranche Position.

Significance of Forex reserves

• It limits external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed.
• The reserve facilitates external trade and payment and promotes orderly development and maintenance of foreign exchange market in India.
• To ensure that the RBI has backup funds if the rupee rapidly devalues or becomes altogether insolvent.
• If the value of the rupee decreases due to an increase in demand for foreign currency, then the RBI can and does sell the dollar in the Indian money market so that rupee depreciation can be checked.
• A good stock of forex establishes a good image for the country at the international level as trading countries can be sure about their payments, thus helping in attracting foreign trade.

Initiatives taken by the government to increase forex

• Atma Nirbhar Bharat, in which India has to be made a self-reliant nation so that India does not have to import things that India can produce. 
• The government has started schemes like Duty Exemption Scheme, Remission of Duty or Taxes on Export Product (RoDTEP), Nirvik (Niryat Rin Vikas Yojana) scheme etc. 
• Apart from these schemes, India is one of the top countries that attracted the highest amount of Foreign Direct Investment, thereby improving India’s foreign exchange reserves.

What is the rupee’s exchange rate?

• It is directly related to India trading with other countries in the world.
  • Trading involves all kinds of transactions such as Indians importing goods, Indians exporting goods, a company engaging the services of an Indian software firm, India allowing a US bank to open its branch in India etc.
• For every rupee demanded in the market, there is a demand for a US dollar.
• But if over time more dollars are demanded than the rupee (because of more import) then the dollar would appreciate against the rupee.
  • If this trend continues the rupee will keep becoming weaker and weaker and its exchange rate will keep falling.

Impact of rupee’s exchange rate

• Weaker rupee benefits India’s exporters.
• Stronger rupee will hurt India’s attempt to become a global exporting hub.

Way Forward

• Steps to boost forex inflows and push the value of rupee include doubling the borrowing limits for companies from overseas to $1.5 billion.
• Temporarily removing interest-rate cap for banks to attract deposits from NRIs and relaxing rules for foreigners to invest in local-currency bonds.
• Key reason why RBI intervenes in the forex market is to smoothen the volatility of the exchange rate. Wild fluctuations on either side are ruinous and erode credibility in a country’s currency.

Source: IE