The Case of Rising Forex Reserve.

Last month, our forex reserves hit a lifetime high and crossed the $500 billion mark. What are forex reserves, you ask? Foreign exchange (forex) reserves are assets with the central bank in external currencies, Bonds, gold, and other rights. India has most of its forex reserves in US treasury bills (short term government Bonds), gold and special drawing rights from the IMF.

Firstly, why would a country need foreign reserves in the first place? The answer has to do with the value of the domestic currency. As a general standard, let’s value the rupee with the US dollar. Let’s assume the current exchange rate is 75Rs/$. If the exchange rate changes to 80Rs/$, it is said that the rupee falls or depreciates or has become weaker. If it cost you 75k to buy an iPhone then, it will cost you 80K now. Similarly, if this goes in the opposite direction, the rupee is said to appreciate or rise.

Forces of Demand and supply determine forex prices. If there is an abundance of rupees in the market, it will be weaker against the dollar (or any other currency) than when there is less money supply. Here is where the forex comes into the picture. If the rupee performs poorly, the RBI will buy foreign assets (using rupee), causing a decrease in the supply of rupee in the market, thus driving up prices and making the rupee stronger. Similarly, if the rupee is strong, the RBI would sell its forex reserves and increase the rupee supply to weaken the currency.

A stable currency is essential! It allows the government and companies to plan with less uncertainty. if the currency appreciates, exports become expensive, and when it depreciates, imports become expensive. This is why the central bank tries to keep currency prices stable.

So why are our forex reserves ballooning? COVID 19, Well partly. Our country imports most of its crude oil, and it pays for it in USD. During the pandemic, the oil demand is deficient, and crude oil prices have dropped quite a bit. This has caused our reserves to pile up. The other main reason is foreign investment. Contrary to what one might assume, many investors are pouring in billions of dollars in our economy. (e.g., JIO and Facebook.

If we have $500+ billion, and the economy is struggling to survive, why don’t we use that $500 billion to boost the economy? Let’s say we do this. The RBI has to convert the dollars into rupees. It starts selling dollars for rupees, to pump it into the economy. The result; Rupee starts depreciating. Imports become expensive. And India is a net importer; it imports more than it exports. So it is evident that the RBI can’t just pump money like that. On the bright side, a high foreign reserve means that the country can keep paying its debts and expenses. It makes investors confident. Currently, we have enough to sustain our import expenses for over a year!

— Avichal Agrawal (Co-founder editor)