Foreign Exchange Reserves are assets held by the Reserve Bank of India (RBI) in foreign currencies to manage the balance of payments and stabilize the rupee. This chapter explores their composition, importance, and management, tailored for UPSC Prelims preparation.
Composition of Foreign Exchange Reserves
India’s forex reserves comprise various components, primarily held in liquid foreign assets, as reported weekly by the RBI.
Foreign Currency Assets (FCA): Largest component (~90%), includes US dollars, euros, pounds, and yen held in securities or deposits. FCA stood at $617 billion in June 2025.
Gold Reserves: Physical gold held by RBI, valued at market prices (~7%). Gold reserves were $56 billion in 2025.
Special Drawing Rights (SDRs): International reserve assets allocated by the IMF (~1.5%). India held $18 billion in SDRs in 2025.
Reserve Tranche Position (RTP): India’s quota contribution to the IMF (~1%), valued at $13 billion in 2025.
Example: In 2024, India’s forex reserves peaked at $704 billion, with FCA contributing $621 billion, driven by strong FDI and FPI inflows.
Importance of Foreign Exchange Reserves
Forex reserves are critical for economic stability, trade, and investor confidence.
Balance of Payments (BoP) Stability: Funds imports and external debt repayments (e.g., India’s import cover was 11 months in 2025).
Rupee Stabilization: RBI intervenes in forex markets to curb rupee volatility (e.g., selling $20 billion in 2022 to support the rupee).
Investor Confidence: High reserves signal economic strength, attracting FDI and FPI.
Crisis Buffer: Protects against external shocks like oil price spikes or capital outflows (e.g., 1991 BoP crisis).
Monetary Policy Support: Enables RBI to manage liquidity during global economic fluctuations.
Example: During the 2022 Russia-Ukraine crisis, India’s $630 billion reserves cushioned oil import costs, preventing a BoP crisis.
Management of Foreign Exchange Reserves
The RBI manages forex reserves under the RBI Act, 1934, balancing safety, liquidity, and returns.
Objectives: Ensure liquidity for BoP needs, minimize risks, and earn reasonable returns.
Investment Strategy: Reserves are invested in low-risk assets like US Treasury bonds, AAA-rated securities, and deposits with foreign central banks.
Forex Market Intervention: RBI buys/sells dollars to manage rupee exchange rates (e.g., sold $40 billion in 2023 to curb rupee depreciation).
Sterilization: RBI uses Open Market Operations (OMO) to neutralize excess liquidity from forex interventions (e.g., bond sales in 2024).
Regulation: Governed by FEMA, 1999, with oversight by RBI’s Financial Markets Committee.
Example: In 2024, RBI’s purchase of $10 billion in US dollars strengthened the rupee, followed by OMO bond sales to control domestic liquidity.
Key Concepts for Prelims
Understanding related terms is essential for UPSC Prelims.
Balance of Payments (BoP): Record of all international transactions; forex reserves fund current and capital account deficits.
Import Cover: Number of months forex reserves can fund imports (e.g., 11 months in 2025).