Increasing Foreign Reserves
During the present pandemic, the economy of India is suffering and the exports of the country fell to a record low. There is an unprecedented fear among the people and the organizations about the economy in the future post-pandemic. The fear of uncertainty is visible in the volatility among the stock markets. Among these situations, RBI is on the move in increase the forex reserves. This made people think about what is the importance of forex reserves for India, and why in the present pandemic situations RBI is on this move to accumulate the forex reserves. We simplify the move to make you understand the consequences of this move and what is ahead for India.
Forex reserve means that the foreign currencies that are held by RBI. RBI holds few baskets of foreign currencies and Indian forex reserves include dollars, gold, and the International Monetary Fund’s quota for Special Drawing Rights. Most of the reserves are usually held in US dollars given the currency’s importance in international trading and a financial system like a dollar. These are needed to face the situations in terms of crisis and also meet the import demands of the country. That is these foreign currencies needed for importing the goods as while importing we have to pay in foreign currencies. And also these foreign currencies save the economy when Indian rupee is depreciating in its value.
First to note down is RBI is the sole custodian of forex reserves in India. it means it is the one who has complete authority over the forex reserves. It continuously increases or decreases the forex it has to control the value of Rupee. In simple terms, when RBI wants to increase the value of rupee it releases more Forex to market by taking back rupee from the market and hence the supply of foreign currency increases and supply of rupee decreases and in response to this Rupee value Appreciates. contrary to that when foreign currencies are brought by RBI by giving more rupee on to the market, then rupee value depreciates. To understand how RBI controls the rupee value, read this in detail
Now if you see the past few weeks, we see that the value of rupee is falling each day in comparison to the US dollar. This is in contrary to the global pandemic and falling economy. But in this situation, critics go on to claim that RBI has abundant reserves and can interfere to save the rupee value by pumping out forex reserves. But is this a good move?
Now during any crisis, there will be a movement of currencies out of the country. This happens in any country as investors take back the money from the country whenever there is a currency. This results in the devaluation of the domestic currency. And to save the domestic currencies central banks must involve by deploying their reserves. This is done by major economies central banks and hence there is a decrease in the forex reserves that is seen in economies. But in contrary to that RBI goes on to increase the forex reserves.
Now this increase has happened because of some of the important reasons. One of the most important is the Increase in FDI. In terms of India, we have seen an increase in foreign direct investment in the past few weeks. This indicates that global investors believe that India will revive out of the pandemic soon and hence a lot of FDI is seen. These investors brought large amounts of foreign currencies into the domestic market and this helped RBI accumulate the reserves.
Secondly, due to pandemic and complete lockdown, there is a drop in the imports of the country. This reduction in the imports have resulted in the reduced outflow of foreign currency and hence there is more foreign currency in the domestic market. This currency is brought by RBI to increase the forex reserves of the country.
So why RBI is actually buying the currency? Experts have said that this excess accumulated forex will help India in facing the economic crisis of present pandemic. And RBI can use this excess forex reserves to transfer to the government in facing the financial crisis that may arise due to the impact of lockdown.
Now another term is that as you can see the rupee value is depreciating. In the way RBI increasing its Forex reserves, RBI is buying a lot of foreign currency from the market and this results in depreciating the rupee. Now when the country needs to stabilize after the Pandemic, RBI can simply sell the foreign currency and buy the rupee from the market. This gets better returns for the RBI. For example, Presently RBI is buying foreign currency at a rate of 74 rupees = 1$. and post-pandemic if the rupee value is 79 per dollar, due to depreciation because of the present pandemic. Then to stabilize the economy RBI sells the foreign currency and buys Indian rupees.at that point of time RBI gets 79 rupees for each dollar. Hence there is a profit for the government which can actually be used for the development of economy post-pandemic. This is what experts are expecting from the present move of RBI buying spree.
In some reports, it is claimed that RBI is building a big reserve to face the future depreciation of the rupee. RBI believes that present FDI in the stock market is not permanent and whenever there is volatility, investors will withdraw money from India and in such scenario, RBI has to be in a position to prevent rapid depreciation of the rupee. So building a huge reserve will keep RBI in a comfortable position when compared to other banks to stabilize the domestic currency.
And also, in addition, to safeguard the value of the domestic currency, having a huge forex reserve is an indicator among the global market that Indian is in a comfortable position to pay for its imports and face the uncertain future. This brings a positive outlook on the Indian economy for global investors.
So the present move by RBI may be seen as a move to prepare for the uncertain future. And also a large plan for the post pandemic Economy.
Until then see you in next article..