News: Why did foreign exchange reserves fall $70 bn in 2022?


What's in the news?

       After three consecutive years of rise, India’s foreign exchange reserves declined by around $70 billion in 2022 amid rising inflation and interest rates.

       From $632.74 billion as of January 7, 2022, the reserves declined to $562.851 billion as of December 30, 2022, even as the Reserve Bank of India used its forex arsenal to stabilize the rupee and cushion the capital outflows.


Foreign Reserves:

       Foreign exchange reserves are the foreign currencies held by a country's central bank.

       Foreign exchange reserves take the form of banknotes, deposits, bonds, treasury bills, and other government securities.

       Foreign exchange reserves are a nation’s backup funds in case of an emergency, such as a rapid devaluation of its currency.

       Most reserves are held in U.S. dollars, the global currency.


Components of Forex:

The four components of forex reserves are as follows.

  1. Foreign Currency Assets (FCAs)
  2. Gold Reserves
  3. Special Drawing Rights (SDRs)
  4. Reserve position with the International Monetary Fund (IMF).


Countries with Forex reserves:

  1. China – $3,349 Billion
  2. Japan – $1,376 Billion
  3. Switzerland – $1,074 Billion


Why is forex reserve important for a country?

       Countries use their foreign exchange reserves to keep the value of their currencies at a fixed rate.

       Maintain liquidity in case of an economic crisis.

       Provide confidence to the foreign investors.

       They reduce the likelihood of balance-of-payments crises, help preserve economic and financial stability against pressures on exchange rates and disorderly market conditions, and create space for policy autonomy.

       To meet its external obligations. These include international payment obligations, including sovereign and commercial debts. They also include financing of imports and the ability to absorb any unexpected capital movements.


Reasons for the decline:

1. Fall in foreign currency assets (FCAs) - The foreign currency assets also include the effect of appreciation or depreciation of non-US units like the euro, pound and yen held in the reserves.

2. Appreciation of the US dollar - The demand for dollars remained high as the Russia-Ukraine war led to a spike in oil and commodity prices.

3. Capital outflows by foreign portfolio investors (FPIs) - FPIs pulled out $21.43 billion since September 2021 as the US Federal Reserve started monetary policy tightening and interest rate hikes.

4. Effect of gold prices - Decline in gold prices has also played a part in the decline in foreign exchange reserves.