About: Foreign Exchange Reserves
Foreign exchange reserves are the foreign currencies held by a country’s central bank.The reserves in India are managed by the Reserve Bank of India for the Indian government and the main component is foreign currency assets.
Reserve Bank of India accumulates foreign currency reserves by purchasing from authorized dealers in open market operations.
Reserve Bank of India Act and the Foreign Exchange Management Act, 1999 set the legal provisions for governing the foreign exchange reserves.
The demands on forex reserves are determined by the size of the external sector to GDP ratio, the degree of openness of the economy, and liquidity requirements.
Components of India’s Foreign exchange reserves:
(1) Foreign Currency Assets (FCA)
FCA is maintained as a multi-currency portfolio comprising major currencies such as the dollar, euro, pound sterling, Japanese yen, etc, and is valued in terms of dollars.
Additionally, it also comprises investments in US Treasury bonds, bonds of other selected governments, deposits with foreign central and commercial banks.
This is the largest component of the Forex Reserves.
The variations in the FCA occur mainly on account of purchase and sale of foreign exchange by RBI, income arising out of the deployment of forex reserves, external aid receipts of the central government and changes on account of revaluation of assets.
Gold reserve is the gold held by the Reserve Bank of India with the intention to serve as a guarantee to redeem promises to pay depositors, note holders (e.g. paper money), or trading peers, or to secure a currency.
(3) Special Drawing Rights (SDRs)
Special drawing rights (SDR) refer to an international type of monetary reserve currency created by the International Monetary Fund (IMF) in 1969 that operates as a supplement to the existing money reserves of member countries.
Created in response to concerns about the limitations of gold and dollars as the sole means of settling international accounts, SDRs augment international liquidity by supplementing the standard reserve currencies.
SDRs are allocated by the IMF to its member countries and are backed by the full faith and credit of the member countries’ governments.
Value of SDR:
The value of the SDR is calculated from a weighted basket of major currencies, including the U.S. dollar, the euro, Japanese yen, Chinese yuan, and British pound.
The SDR basket is reviewed every five years, and sometimes earlier if warranted. Reviews take place to ensure that the SDR reflects the relative importance of currencies in the world’s trading and financial systems.
Weightage of various currencies in SDR as determined in the 2015 review:
S. Dollar: 41.73
Chinese Yuan: 10.92
Japanese Yen: 8.33
Pound Sterling: 8.09
(4) Reserve Tranche Position (RTP)
The primary means of financing the International Monetary Fund is through members’ quotas. Each member of the IMF is assigned a quota, part of which is payable in SDRs or specified usable currencies (“reserve assets”), and part in the member’s own currency.
The difference between a member’s quota and the IMF’s holdings of its currency is a country’s Reserve Tranche Position (RTP).
It is basically an emergency account that IMF members can access at any time without agreeing to conditions or paying a service fee. In other words, a portion of a member country’s quota can be withdrawn free of charge at its own discretion.
The reserve tranches that countries hold with the IMF are considered their facilities of first resort, meaning they will tap into them before seeking a formal credit tranche that charges interest.
Weightage of various components:
As on December 20, 2019, the proportion of various components in India’s forex reserves is:
FCA – 93% of total forex
Gold – 6%
SDR – 0.32%
RTP in the IMF – 0.8%