HPAS/Allied Mains 2022 Answer Writing Challenge Day 195: Model Answer

Question: What is Foreign Exchange Reserve or Forex Reserve? Also discuss the Objectives Behind Holding Forex Reserves. (8 marks/ 120 words)

Answer:

Foreign Exchange reserves or Forex reserves are assets such as foreign currencies, gold reserves, treasury bills, etc retained by a central bank or other monetary authority that checks the balance payments and influences the foreign exchange rate of its currency and maintains stability in financial markets.

RBI is the custodian of the foreign exchange reserves in India. In 2020, India’s forex reserves crossed the $500-billion mark for the first time in history due to higher foreign direct investment, foreign institutional investment. Low oil prices also helped reduce outflows. This gave India an adequate cushion to combat external shocks.

The biggest contributor to this reserve is foreign currency assets followed by the gold, SDR, and reserve with the International Monetary Fund.

Objectives Behind Holding Forex Reserves:

1. The most significant objective behind this is to ensure that RBI has backup funds if their national currency rapidly devalues or becomes altogether insolvent.
2. If the value of the Rupee decreases due to an increase in demand of the foreign currency, then RBI sells the dollar in the Indian money market so that depreciation of the Indian currency can be checked.
3. A country with a good stock of forex has a good image at the international level because the trading countries can be sure about their payments.
4. A good forex reserve helps in attracting foreign trade and earns a good reputation in trading partners.