Models of reserve demand play an important role in determining the volatility of reserve increments and the opportunity cost for reserve holding.
The accretion rate of official reserves has been more than 1000% over the past 20 years, despite a growing acceptance of a flexible exchange rate system and a sharp fall in the effective real return on reserve holdings. There have also been restrictions and limitations on cross-border capital flows. The reserve volume stood at US$ 9.832 trillion in March 1993 when a market-based exchange system was introduced. The level of reserves has increased steadily to reach US$ 130.00 million by February 2005. India was one of the five largest reserve holding emerging countries at that point. Six times more Indian Forex reserves have been created since then.
The decline in India’s Forex reserves during the reporting week was due to a decrease in foreign currency assets (FCAs), which is a significant component of overall reserves.
According to data from the Reserve Bank of India (RBI), India’s foreign exchange reserves fell by $2.47B to $616.895 Billion in the week ending August 20, 2021. Foreign Exchange Reserves in India are foreign assets that the central bank controls or holds. These reserves can be made up of gold or a particular currency. They may also include special drawing rights or marketable securities that are denominated as foreign currencies, such as treasury bills and corporate bonds.
According to RBI data, Forex reserves fell by $2.099 Billion to $619.365 Billion in the week that ended on August 13, 2021. In the week ending August 6, 2021, the reserves reached a record $621.464 billion.
One of the important contributors to general growth in official reserves is the imposed restrictions on Forex trading. As per the SEBI regulation, local brokerage companies cannot offer any currency pairs that do not involve the Indian rupees. This rule plays a significant role, as if you were to go through all Asian FX brokers reviewed, you would not find a single one of them regulated by an Indian authority. The absence of trading rights of foreign currency pairs is what constitutes the fact that India has one of the largest foreign currency reserves to this point.
As per regular data updates provided weekly from the central bank, Forex reserves dropped by 3.365 billion to $573.009 billion during the reporting week. This was due to a decrease in foreign currency assets (FCAs), which is a significant component of overall reserves. The week under review saw the FCAs fall by $3.365Billion to $573.009 Billion.
In dollar terms, foreign cash assets are the impacts of appreciation or decline of non-US units like the euro, pound, and yen that are held in foreign exchange reserves.
There are not many issues that concern reserve accumulation in India. Despite the significant increase in cross-border capital flows many transactions on the capital account remain restricted and capital outflows are not always as free as those inflowing. This asymmetric control of capital flows is an integral part of the Indian reserve management.
India requires substantial liberalization in order to achieve financial integration. These restrictions reduce the vulnerability of the exchange system to external shocks. Therefore, it would be reasonable to expect lower demand for reserves as a precautionary reserve. It is fascinating to see the coexistence of high reserves and financial repression. This raises questions about whether greater cross-border capital flows are contributing to growing precaution.
The view that an unprecedented accumulation of reserves has led to a consensus is a general notion. Some emerging countries have a notable rise in reserve demand as a result of increased financial and banking crises. Recent empirical studies on reserve demand support this claim. It is interesting to note, however, that India remains one of the top reserve holding countries.
Countries’ capital account transactions are still managed and capital outflows may not be as easy as capital inflows. This asymmetric control of capital flows is intended to prevent the country from facing currency crises or other speculative attacks. Why should the authority accumulate large amounts of reserves if this is true?
According to RBI data, gold reserves rose by $913 million to $37.249 Billion in the reporting week. Special drawing rights (SDRs), with the International Monetary Fund, (IMF), fell by $3 million to $1.541 trillion. The country’s reserves with the IMF fell by $15 million to $5.096 Billion.
