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Day 29 – Q 3. Discuss the factors that have helped the RBI to maintain a healthy foreign exchange reserve. What are its benefits to the economy? Explain. (15 Marks)

  • IASbaba
  • February 28, 2022
  • 0
GS 3, Indian Economy, TLP-UPSC Mains Answer Writing
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3. Discuss the factors that have helped the RBI to maintain a healthy foreign exchange reserve. What are its benefits to the economy? Explain. (15 Marks)

उन कारकों की चर्चा कीजिए जिन्होंने भारतीय रिजर्व बैंक को एक स्वस्थ विदेशी मुद्रा भंडार बनाए रखने में मदद की है। अर्थव्यवस्था के लिए इसके क्या लाभ हैं? समझाएं।

Approach-

Candidates need to first explain about Forex exchange reserve and discuss the factors that have helped the RBI to maintain a healthy foreign exchange reserve. Also, the candidate needs to mention its benefits to the economy.

Introduction

Forex reserves are external assets, in the form of gold, SDRs (special drawing rights of the IMF) and foreign currency assets (capital inflows to the capital markets, FDI and external commercial borrowings) accumulated by India and controlled by the Reserve Bank of India.

The factors that have helped the RBI to maintain a healthy foreign exchange reserve includes:

  • The major reason for the rise in forex reserves is the rise in investment in foreign portfolio investors in Indian stocks and foreign direct investments (FDIs). 
  • Post-Covid, there has been a sharp fall in the volume and value of India’s imports as compared to exports. 
  • Crude oil is the main item of India’s imports. In fact, India is the third biggest importer of crude oil after China and Japan. Around 85 per cent of the crude oil requirement is met through imports. 
  • Fall in demand coupled with fall in the price of crude oil has brought down India’s oil import bill significantly, saving precious foreign exchange.
  • Similarly, the import of many electronics products (mobile phones, laptops, notebooks, tablets, smartwatches, earphones etc.) from China has declined in the wake of Indo-China stand-off at the Ladakh border. 
  • The drop in imports is also attributable to the import substitution policy of the government under Aatmanirbhar Bharat Abhiyan (Self-reliant India Initiative).
  • In the capital account too, non-debt inflows in the form of foreign investments, both direct and portfolio, have increased, leading to accretion in foreign exchange reserves.

Its benefits to the economy 

  • Foreign exchange reserves act as a cushion against rupee volatility which can be caused due to many reasons, including variations in interest rates in the US and other developed countries. 
  • RBI intervenes to stabilize the rupee against the dollar whenever there is excessive volatility in the exchange rate. It sells dollars in the foreign exchange market whenever rupee weakens and buys dollars when it strengthens. 
  • The exchange rate moves within a band as per the current policy of the RBI in this regard. Thus, from the point of view of the RBI, the level of reserves is intricately linked with the exchange rate management.
  • India’s robust and swelling foreign exchange reserves provide confidence to credit rating agencies and prospective foreign investors that external obligations of the country can always be met and that India has the ability to manage the balance of payments. 
  • Hefty reserves guarantee timely payment for repatriation of profits and portfolio outflows, both crucial to attract direct and portfolio foreign investments.  
  • Similarly, adequate foreign exchange reserves enhance the confidence of domestic investors and the general public by demonstrating that national currency is backed by external assets. 
  • Moreover, foreign currency reserves act as the first line of defence to address unanticipated contingencies that can occur suddenly.
  • They are held in the national interest to meet any unpredictable demand for foreign currency and serve as a means of crisis prevention. 

Conclusion

The RBI Act, 1934 provides the overarching legal framework for deployment of reserves in different foreign currency assets and gold within the broad parameters of currencies, instruments, issuers and counterparties.  The Reserve Bank functions as the custodian and manager of forex reserves, and operates within the overall policy framework agreed upon with the government. In short, holding massive reserves of US dollars, Euros, Pound Sterling and Japanese Yen is a positive factor for emerging India.

 

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