For the first time in four weeks, India foreign exchange reserves decreased, falling to $575.27 billion during the week ending February 3, according to Reserve Bank of India data released on Friday. The reserve loss this time was 1.5%, which is the largest since October 2022

India foreign exchange holdings fell by $1.5 billion on February 3 to reach $575.3 billion.

The week prior, which ended on January 27, saw reserves at $576.76 billion.

The nation’s foreign exchange holdings fell by $1.3 billion to $507.7 billion in the same week.

For the purpose of reducing exchange rate volatility, the central bank gets involved in the spot & forward markets. The RBI has declared in the past that variations in reserves are also a result of gains or losses in valuation.

In the same week, the exchange rate of the rupee against the US dollar decreased by 0.7%, fluctuating widely between 81.49 and 82.31.

On concerns that the better-than-expected U.S. jobs data may lead the Federal Reserve to act, the rupee experienced its largest weekly decline in two months this week, ending on February 10.

What Are Foreign Exchange Reserves?

A central bank’s holdings in foreign currencies are known as foreign exchange reserves. These reserves are employed to support obligations and affect monetary policy. Any foreign currency held by the a central bank, such as the Federal Reserve Bank of the United States, is included.

A country’s central bank holds assets with a foreign currency value that are referred to as foreign exchange reserves.

Foreign money, bonds, treasury bills, and many other government securities may be among them.

China is the largest holder of foreign exchange reserves globally, with the majority of them being held in U.S. dollars.

The best way to hold foreign exchange reserves, according to economists, is in a currency that is not pegged to the nation’s own currency.

How Foreign Exchange Reserves Work ?

Banknotes, deposits, bonds, treasury bills, and other types of government securities can all be included in foreign exchange reserves.

These assets have many uses, but they are primarily kept as a safety net in case a central government agency’s home currency depreciates sharply or goes bankrupt.

The practise of a central bank maintaining sizable reserves inside its foreign exchange is widespread throughout the world. Since the dollar is the most traded currency globally, the majority of such reserves are held in this currency. The British pound (GBP), the euro (EUR), the Chinese yuan (CNY), or the Japanese yen (JPY) are frequently used as the basis for foreign exchange reserves.

In order to act as a buffer in the event of a market shock, economists contend that it is preferable to hold foreign exchange reserves in a currency that isn’t pegged to the nation’s own currency.

However, as global trading has gotten simpler and currencies have gotten more intertwined, this practise has become more challenging.

Purpose of keeping foreign exchange reserves

To maintain a fixed exchange rate for their respective currencies.

India foreign exchange, Forex reserves are used by nations with such a floating exchange rate system to maintain the value of their currencies below the US Dollar.

To preserve liquidity in the event of a financial crisis.

To maintain market stability, the central bank (RBI) provides foreign currency.

to make certain that a nation fulfills its liabilities and obligations abroad.

Why Forex reserves are important?

Stronger foreign currency reserves will enable central banks in developing markets to “buffer their currencies against significant decline by supplying dollars to the market” during volatile times, claims a Goldman Sachs report.

If the RBI is managing India’s external and internal financial issues at a time of significant contraction in economic growth (23.9%), the government will be in a comfortable position.

It helps the government fulfil its obligations for both external debt and foreign exchange.

Rupee appreciation – The rupee has gained strength against the dollar as a result of growing foreign exchange reserves.

The India foreign exchange reserve peaked in October 2021 at USD 645 billion. As the central bank uses its funds to defend the rupee against pressures primarily brought on by global events, reserves have been declining.

According to the RBI’s Weekly Statistical Supplement for the week ending February 3, the foreign currency assets, a significant part of the reserves, decreased by USD 1.323 billion to USD 507.695 billion.

The value of non-US currencies like the euro, pound, and yen held in foreign exchange reserves is reflected in the foreign currency assets, which are expressed in dollar terms.

The RBI reported that after increasing for several weeks, gold reserves fell by USD 246 million to USD 43.781 billion.

To reach USD 18.544 billion in the week, the Special Drawing Rights (SDRs) increased by USD 66 million. According to data from the apex bank, the nation’s reserve position with the IMF increased by USD 9 million to USD 5.247 billion during the reporting week.

The India foreign exchange reserves hit an all-time high of USD 645 billion in October 2021. The reserves have been dropping as the central bank uses its funds to defend the rupee against pressures primarily brought on by international events.

To reach USD 18.544 billion, the Special Drawing Rights (SDRs) increased by USD 66 million. According to data from the apex bank, the nation’s reserve position with the IMF increased by USD 9 million to USD 5.247 billion during the reporting week.

How are foreign exchange reserves used, and how does that affect the economy?

As the central bank continued to respond to the depreciation of the rupee, the country’s foreign exchange reserves further decreased to a level not seen in over two years. While protecting the currency against decline, the central bank, however, appears to have been unaware of the declining foreign exchange reserves.

The spot foreign exchange reserves have decreased from a high of $642.45 billion announced in September of last year, when they were at a record high of $607 billion, to a low of about $117.93 billion at the end of March.

Foreign exchange reserves decreased to a pitiful $528.37 billion for the week, their lowest level since July 2020. Foreign currency assets, which make up a sizeable portion of the overall reserves, are to blame for the decline.

For the week ending October 21, foreign currency assets decreased by $3.59 billion to $465.08 billion. To $37.21 billion, gold reserves decreased by $247 million. The rupee dropped for a sixth consecutive week during the week ending October 21, reaching an all-time low and falling below the 83-per-dollar level. The dollar has decreased by about 4% over the past six weeks.

The reserve bank now has depleted close to $118 billion out of its Forex coffer to aid the rupee’s decline and fend off the effects of rising dollar valuation. However, the central bank declares that valuation effects are to blame for two-thirds of the decline.

The week ending January 20, 2023, saw an all-time high for India’s foreign exchange reserves over the previous six months. According to recent data released by the Reserve Bank of India (RBI) on January 27, the total foreign exchange reserves were USD 573.7 billion on January 20.

According to the Weekly Statistical Supplement published by the RBI, the foreign currency assets, a significant part of the reserves, decreased by USD 1.323 billion to USD 507.695 billion for the week ended February 3.

The value of the appreciation or depreciation of non-US currencies like the euro, pound, and yen held in foreign exchange reserves is included in the foreign currency assets, expressed in dollar terms.

The RBI reported that after increasing for several weeks, gold reserves fell by USD 246 million to USD 43.781 billion.

The rising dollar, rising US interest rates, and a slowing global economy are just a few of the factors contributing to the record decline in global currencies. According to data reports, global central bank interventions to support national currencies have reduced global foreign exchange reserves by about $1 trillion.

According to a report released last week by Fitch Ratings, the reserve cover was approximately 8.9 months’ worth of imports in September. This gives the government more flexibility to use reserves to ease times of external stress because it is higher than during the “taper tantrum” in 2013, when it stood at roughly 6.5 months.

Countries utilise their foreign exchange reserves to maintain a fixed exchange rate for their national currencies; China, for instance, pegs the Yuan to the US dollar. China keeps cash on hand to make the dollar more valuable than the Yuan. Making Chinese exports less expensive than products made in the US will boost sales.

Reserves are used by nations with floating exchange rates to keep their currency’s value below the US dollar. The same justification as nations with fixed-rate systems drives these nations to take this action.

In the event of an economic crisis, the central bank may also use the reserves to maintain liquidity. For instance, a nation might halt exports in an emergency, which would leave them in the bind of not having enough foreign currency for imports. In this scenario, the central bank may convert its foreign currency into local currency, enabling imports to be paid for and received.

To maintain market stability, the central bank provides foreign currency. To reassure foreign investors, they either buy local currency or sell it on spot exchanges to help to prevent situations of extreme inflation.

To fulfil its external obligations, such as sovereign and commercial debts, the central bank controls a specific amount of foreign currency. They support the ability to absorb any unforeseen capital movements as well as the financing of imports.

To ensure they generate positive returns without compromising security, central banks diversify their reserve investments. They frequently possess gold or other assets that earn interest.