India’s sterling, and the Japanese yen. Foreign exchange

India’s Foreign Exchange reserves recently crossed US$400 billion for the first time in its history in November 2017. Forex reserves is money or other assets held by a central bank of respective country or other monetary authority so that it can pay if need its liabilities, such as the currency issued by the central bank, as well as the various bank reserves deposited with the central bank by the government and other financial institutions. Reserves are held in one or more reserve currency, mostly the United States dollar and to a lesser extent the EU’s euro, the British pound sterling, and the Japanese yen. Foreign exchange reserves play’s a crucial role in the component of balance of payments and also an essential element in the analysis of an economy’s external position. The level of India’s foreign exchange reserves consists foreign currency assets (FCA), gold, SDRs and reserve tranche position (RTP) in the IMF. Countries use their foreign exchange reserves to keep the value of their currencies at a proper rate at the time of extreme market volatility and also the main function is to maintain liquidity in case of an economic crisis. For example, a flood or volcano might temporarily suspend local exporters’ ability to produce goods. That cuts off their supply of foreign currency to pay for imports. In that case, the central bank can exchange its foreign currency for their local currency, allowing them to pay for and receive the imports. The central bank supplies foreign currency to keep markets steady. It also buys the local currency to support its value and prevent inflation.Reserve Bank of India Act and the Foreign Exchange Management Act, 1999 set the legal provisions for governing the foreign exchange reserves in India. Reserve Bank of India accumulates/disperse foreign currency reserves by purchasing/selling from authorized dealers in open market operations whenever required. Foreign exchange reserves of India act as a cushion against rupee volatility once global interest rates starts rising.In India RBI releases reserves information every Friday. India’s Foreign exchange reserves peaked at US$ 411 as on 5th January 2018 as per data released by Reserve bank of India as on 12th Jan 2018 of which US$ 387 billion (94.16%) in the form of foreign currency assets, US$ 20.5 billion (5%) in gold, US$ 1.5 billion (0.36%) in SDR’s and US$ 2 billion (0.48%)in reserve tranche position (RTP) in the IMF. Gold as a proportion of our reserves is relatively small with just 5% still it stood at second position After foreign currency assets in our reserves. Gold is the ultimate currency in India. In fact, only gold came to our rescue during 1991 crisis. The increase in forex reserves in India from last few years demonstrates the underlying strength of its balance of payments with increase in FDI, FII and NRI investments, particularly from 2014.Reserves are always needed to make sure a country will meet its external obligations. These include international payment obligations, including sovereign and commercial debts. If we observe imports in India during the Dec 2017 are stood at US$ 41.91 billion, so with the current level of reserves it can cover 9 ½ months of imports easily.In world more than 100 countries maintaining forex reserves and provides data to IMF on weekly (or) monthly (or) quarterly (or) yearly basis depends on the country. China is in top position with US$ 3.1 trillion as on 31st March 2017 and then Japan and Switzerland in 2nd and 3rd place with reserves US$ 1.23 trillion and US$ 730.4 billion. India stood at 10th position in maintaining forex reserves with US$ 369.95 billion as on 31st March 2017. As per figure.1 there are 24 nations in the world which are maintaining more than US$ 100 billion.                                 Figure –  1                                                                                                         Source: data.imf.org If we compare India with BRICS nations, still India is at 4th place out of 5 nations. Please refer figure 2 for more details.Country Name Forex Reserve Assets As on 31st Mar 2017   (US $ Millions) China                  3,102,764 Russia               397,907 Brazil               370,111 India               369,955 South Africa                 46,588 Figure –  2                     Source: data.imf.orgTwo important aspects of managing the reserves are:1) Assessing the benefits of holding the reserves2) Assessing the opportunity cost of managing the reservesAssessing the benefits of holding the reservesThe major benefit of holding the sufficient reserves is that it acts as a buffer during the forex market pressures & thereby helps to prevent the external crisis, especially the ones which emerges from the capital account. For emerging economies like India, higher levels of forex reserves provide assurance to the global community that external liability will be paid and exchange rate will be stabilized as and when required. The flip side of higher level of forex reserves is that it locks domestic currency in foreign currency assets which otherwise could be used for increasing domestic investment. On the other hand, for emerging economies like India, the lower level of foreign exchange reserves is a curse as it limits the ability of central bank to intervene in forex market to stabilize exchange rate and equalize the balance of payment which could ultimately lead to depreciation of domestic currency.      In 1991, when India faced its worst ever balance of payment crisis, the country had to pledge 67 tonnes of gold to Union Bank of Switzerland and Bank of England to raise $605 million (Rs2,843.5 crore today) to shore up its dwindling foreign exchange reserves, which were then barely enough to buy two weeks of imports. India’s foreign exchange reserves were at $1.2 billion in January 1991 and by June, they were depleted by half. barely enough to last for roughly 3 weeks of essential imports.18 years after the incident, in 2009, India bought 200 Metric tons of gold from International Monetary Fund which was nearly three times the amount which India pawned to IMF in 1991From 2001 India is maintain a large amount of forex reserves. As per figure 3, In 2001 Indian forex reserves stood at US$ 42 billion and now it is US$ 411 billion within 17 years of time it has increased 10 times roughly. But if we observe there is a major fall from 2008 to 2009 it is because of 2008 global crisis. in 2008 crisis, Indian reserves are peaked at US$ 314.6 billion at end-May 2008. The reserves declined thereafter to US$ 247.7 billion at the end of November 2008 and were at US$ 252.0 billion at the end of March 2009. Fallout of the global crisis and strengthening of the US dollar vis-à-vis other international currencies has been responsible for the decline.A major fallout of the global financial crisis has been the reversal of portfolio flows (net outflow of US$ 11.3 billion during April-December 2008). Together with the widening trade deficit, such outflows have upset the supply-demand balance in the domestic foreign exchange market, leading to decline in the rupee exchange rate vis-à-vis US dollar. The value of rupee declined from Rs 40.0 in April 2008 to Rs 48.66 in October 2008. The currency came under sharp pressure after the collapse of the Lehman Brothers in September 2008. The Reserve Bank, therefore, intervened to augment supply in the domestic foreign exchange market aimed at reducing undue volatility. The rupee thereafter attained a measure of stability. The exchange rate was Rs. 51.2 per US dollar in March 2009 Figure – 3                                                                                       Source: rbi.org.in & data.gov.in*In 2018 forex reserves are as on 5th Jan 2018 (as on 31st March from 2001 – 2017)  Assessing the opportunity cost of managing the reservesOur Ex RBI governor Raghuram Rajan once said that reserves cannot buy a country immunity from volatility in global currency markets and at best will prevent second round impacts of that volatility, “Reserves are useful to have but they come at a cost”. Yes, by maintaining huge reserves we are losing the opportunity cost. India’s foreign exchange reserves are parked in US treasury bonds, which earn just one percent annual interest i.e., US$ 4 billion on US$ 400 billion reserves. But India has a total debt of US$ 1.20 trillion (RS. 75 Lac crore) including both internal and external. The annual interest outgo on this debt is US$ 87 billion (Rs. 5.23 lac crore) as per the 2017-18 Union budget. This means India is paying around 6.5 – 7.5 % interest on its debts. So, by this we can say that India is paying more rate of interest on its debts than what its getting on reserves. References:www.livemint.comwww.indiabudget.nic.inwww.rbi.org.in www.data.gov.inwww.data.imf.orgwww.indiatimes.comwww.hindubusinessline.com