What is Foreign Exchange Reserve?

About Foreign Exchange Reserve

• Foreign Exchange Reserves (also called Forex Reserves) are reserve assets held by a central bank in foreign currencies.
• Foreign assets comprise assets that are not denominated in the domestic currency of the country. 
• These may include foreign currencies, bonds, treasury bills, and other government securities.
• Reserves are denominated and expressed in the US dollar, which is the international numeraire for the purpose.
• RBI is the custodian of the foreign exchange reserves in India.
• India’s foreign exchange reserves comprise of;
  • Foreign currency assets (FCAs): These are maintained in currencies like the US dollar, euro, pound sterling, Australian dollar, and Japanese yen.
  • Gold
  • SDR (Special Drawing Rights): This is the reserve currency with the IMF.
  • RTP (Reserve Tranche Position): This is the reserve capital with the IMF.
• The biggest contributor to India’s Forex reserves is foreign currency assets, followed by gold.
• Purpose:
  • They are used to back liabilities on their own issued currency, support the exchange rate, and set monetary policy.
  • To ensure that RBI has backup funds if their national currency rapidly devalues or becomes altogether insolvent.
  • If the value of the Rupee decreases due to an increase in the demand for the foreign currency, then RBI sells the dollar in the Indian money market so that depreciation of the Indian currency can be checked.
  • A country with a good stock of forex has a good image at the international level because the trading countries can be sure about their payments.
  • A good forex reserve helps in attracting foreign trade and earns a good reputation with trading partners.

Q1) What are bonds?

A bond is a fixed-income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental) for a set period of time in return for regular interest payments. The time from when the bond is issued to when the borrower has agreed to pay the loan back is called its ‘term to maturity’. The bond issuer uses the money raised from bonds to undertake various activities, such as funding expansion projects, refinancing existing debt, undertaking welfare activities, etc. 

Source: India's forex reserves up by $2.98 bn to $619.1 bn as of Feb 23