- Date : 21/09/2021
- Read: 6 mins
Get an insight into what forex reserves are, why they are increasing during a pandemic year, and their importance.
In June 2021, India's forex reserves crossed the US $600 billion for the first time. Recently, India also became the world’s fourth largest forex reserves holder. Both these events got a lot of media attention. In this article, we will try to understand why India’s forex reserves are rising during the COVID-19 pandemic. We will also explore the sources of forex reserves, how they are managed, and their importance.
What are forex reserves?
Forex reserves or foreign exchange reserves are assets held by the Reserve Bank of India (RBI) in foreign currency. India’s forex reserves are managed by the RBI and consist of four components:
- Foreign current assets (FCA)
- Special Drawing Rights (SDRs), and
- Reserve position in the IMF
Out of the above four, FCA is the most important as it contributes a significant chunk of overall forex reserves, followed by gold. FCA refers to investments in foreign assets held by the RBI in other countries. Most of them are in USD as it is a global currency, followed by investments in some other currencies.
Table: India’s foreign exchange reserves as of 20 August 2021
As seen in the above table,
India’s foreign exchange reserves as of 20 August 2021 stand at $616 billion.
Out of the total $616 billion, FCAs contribute $573 billion, and gold is valued at $37 billion.
India recently became the fourth largest holder of forex reserves.
Table: Countries with the largest forex reserves
Increase in India’s forex reserves
In the last one year, India’s forex reserves have been increasing steadily.
Chart: Movement in India’s foreign exchange reserves (Sep 2020 – Mar 2021)
As seen in the above chart, in September 2020, forex reserves were around $540 billion. By March 2021, they touched $590 billion. As of August 2021, they are over $600 billion.
Why are India’s forex reserves increasing during a pandemic year?
For the last one and a half years, India and the entire global economy suffered from the COVID-19 pandemic. Global trade has taken a big hit, yet surprisingly India’s forex reserves have increased steadily and reached an all-time high. Let us delve into the reasons for this increase in forex reserves.
1) Foreign Portfolio Investment (FPI)
The stock markets have been hitting new highs regularly for the last couple of months. This is due to increased investments from domestic investors as well as Foreign Portfolio Investments (FPIs). The economy is steadily recovering from the impact of the pandemic, and companies are posting good financial results. As a result, foreign investors are bullish on India and have made huge investments in Indian equities.
Important government announcements such as a cut in the corporate tax rate and a boost to infrastructure in the Union Budget have played a major role in turning foreign investor sentiment positive towards India. According to the RBI, FPI investment was $15 billion between April and December 2019.
2) Foreign Direct Investment (FDI)
India’s start-ups have raised a lot of money from private equity (PE) investors and venture capitalists. It has led to India receiving a lot of foreign direct investment (FDI). Companies like Reliance Industries raised more than $15 billion by selling stakes in Jio and Reliance Retail, thereby adding to India’s forex reserves. The year 2019-20 was the best year for FDI inflow, with $56 billion coming in as FDI.
3) Growth in exports
During the pandemic year, India’s exports have done well. In July 2021, the country’s merchandise exports amounted to $35.2 billion, the highest ever in a month. The biggest contributors to exports were petroleum products, gems and jewellery, engineering goods, and cotton yarn/fabrics.
The demand for IT services has gone up globally. Indian IT companies have announced record order wins and a huge pipeline. They get paid in USD, thereby adding to India’s forex reserves. In 2020-21, IT companies brought in net export earnings of $90 billion. What’s more, India also gets remittances from NRIs and other Indian diaspora.
All the above factors – merchandise exports, IT services, NRI remittances, etc. – have contributed to the increase in India’s forex reserves.
4) Decrease in imports
Due to COVID-19, there are a lot of travel restrictions globally. Due to this, crude oil demand has been affected, and prices fell in 2020-21. For the most of 2020-21, crude oil prices have hovered in the range of $45-65. India, despite being a major importer of crude oil, imported less crude oil than usual due to travel restrictions. Along with crude oil, non-oil imports also took a major hit due to decreased economic activity.
In the last couple of years, the Government has promoted ‘Make in India’ and Aatmanirbhar Bharat. It has announced many schemes such as Production Linked Incentive (PLI). These efforts have started bearing fruit, and some of the products that India used to import earlier are now being produced in the country.
The overall reduction in crude oil and non-oil imports has saved precious forex reserves.
5) RBI’s purchase of dollars to prevent rupee appreciation
As we saw, there has been a sizeable inflow of USD due to huge FPI and FDI investments. This inflow leads to an appreciation of the Indian currency, which makes our exports less competitive compared to other countries. During such times, the RBI intervenes in the forex markets and buys up US dollars to prevent the Indian rupee from appreciating sharply. Such USD purchases have added to our forex reserves.
Importance of forex reserves
The RBI manages forex reserves for several important purposes. Some of these are:
- Paying for India’s imports
- Managing foreign debt
- Stability of the Indian currency (INR)
- Managing foreign capital flows
- Managing any external shock or crisis
The RBI has to maintain a delicate balance when it comes to the management of forex reserves. If the reserves are less than required, India will have difficulty in servicing import payments. If the reserves are more than required, there is a cost to managing them.
The amount of forex reserves also influences the Indian currency. If there are adequate forex reserves, the INR value will remain steady. If the reserves are less than adequate, it can put pressure on the Indian rupee, leading to its depreciation. So, the RBI has to seek a balance while managing adequate forex reserves.