Of late, India has witnessed a mammoth inflow of foreign exchange reserves. From a scary situation once upon a time, India now sits pretty on a huge pile of reserves that have hit a record high. Although these reserves provide comfort in managing any kind of external shocks, they have a certain amount of cost associated with them. Does India hold appropriate amount of reserves to suffice import payments? What are the implications of superfluous reserves? What steps should the RBI take in this direction? Know more from this article.
Conceptually, a unique definition of forex reserves still eludes us as there have been divergent views in terms of coverage of items, ownership of assets, liquidity aspects and need for a distinction between owned and non-owned reserves. Nevertheless, for policy and operational purposes, most countries have adopted the definition suggested by the International Monetary Fund. This defines reserves as external assets that are readily available to and controlled by monetary authorities for direct financing of external payments imbalances, for indirectly regulating the magnitudes of such imbalances through intervention in exchange markets to affect the currency exchange rate, and/or for other purposes.
Technically, there could be three motives i.e., transaction, speculative and precautionary motives for holding reserves. International trade gives rise to currency flows, which are assumed to be handled by private banks driven by the transaction motive. Similarly, speculative motive is left to individuals or corporates. Precautionary motive for holding foreign currency like the demand for money, can be positively related to wealth and the cost of covering unplanned deficit, and negatively related to the return from alternative assets.
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