Central Idea

India’s forex reserves were at $578.4 billion as of March 2023—a fall of over $28 billion since March 2022, $19.7 billion of which was due to valuation changes, as per RBI.
The depreciation of the US dollar and increased capital flows contributed to a surge in reserves this year.

What is Foreign Exchange (Forex) Reserve?

Foreign exchange reserves are important assets held by the central bank in foreign currencies as reserves.
They are commonly used to support the exchange rate and set monetary policy.
In India’s case, foreign reserves include Gold, Dollars, and the IMF’s quota for Special Drawing Rights.
Most of the reserves are usually held in US dollars, given the currency’s importance in the international financial and trading system.
Some central banks keep reserves in Euros, British pounds, Japanese yen, or Chinese yuan, in addition to their US dollar reserves.

India’s forex reserves cover:

US Rate Hikes and Capital Flows: The US Federal Reserve’s rate hikes have triggered a flow of foreign investments into the US treasury, leading to capital outflows from India.
Potential Capital Inflows: So far this year, the US Fed has raised rates by 75 basis points. This could potentially increase capital inflows into emerging markets like India.
Improved Balance of Payment (BoP): India’s Balance of Payment has improved significantly, with the current account deficit projected to be less than 2% of GDP.
Resumption of Equity Capital Flows: There is a resumption in equity capital flows, and India continues to attract substantial investments compared to other emerging market peers.

Rank among Nations: India ranks fourth among countries with the highest forex reserves, following China, Japan, and Switzerland.
Differences in Reserve Accumulation: Most countries maintain large and persistent current account surpluses, owing to a competitive exports market. However, India, Brazil, and the US have accumulated reserves primarily through capital flows rather than a significant current account surplus.

Internationalizing the Rupee: The RBI aims to reduce reliance on foreign currencies by internationalizing the Indian rupee.
Exploring Use of Asian Clearing Union Currencies: The RBI is exploring the use of currencies from member states of the Asian Clearing Union, including the rupee, for payment and settlement among themselves.
Agreement with Sri Lanka: An agreement with the Central Bank of Sri Lanka enables the use of the rupee as a designated foreign currency, promoting trade between the two countries and facilitating rupee transactions for Indian tourists in Sri Lanka.

While India’s forex reserves have seen fluctuations due to various factors, the country’s sustained efforts to diversify and strengthen its reserves position indicate a proactive approach by the RBI.
The ongoing focus on attracting foreign investments, coupled with measures to internationalize the rupee, may contribute to a more stable and resilient forex reserve management system in the future.