FOREIGN EXCHANGE RESERVES
1. Context
Concerned about the falling value of the rupee amid the rise in oil prices and fears over inflation in the wake of the West Asia conflict, the Reserve Bank of India last week instructed banks to limit their net open exposure to the currency in the foreign exchange market to $100 million by the end of each day. Authorised dealers must comply with this rule by April 10.
2. What are foreign exchange reserves?
- Foreign exchange reserves are the stock of foreign money and other external assets kept by a country’s central bank, in India’s case the Reserve Bank of India (RBI). You can think of it as the country’s financial emergency fund in foreign currencies.
- Imagine India as a large household. Just as a family keeps savings in the bank for emergencies, the country keeps a reserve of foreign assets so that it can meet international payments whenever required.
- Since India imports many essential goods—especially crude oil, electronics, machinery, and gold—it has to pay other countries mostly in US dollars or other international currencies. This is where foreign exchange reserves become extremely important.
- These reserves are mainly held in the form of US dollars, euros, pounds, yen, gold, and assets such as US government bonds and treasury bills. They may also include Special Drawing Rights (SDRs) and the reserve position with the IMF.
- To understand it more clearly, suppose India wants to import crude oil from another country. The payment cannot usually be made in Indian rupees because international trade is largely settled in dollars. The RBI uses the country’s foreign exchange reserves to ensure that sufficient dollars are available in the system for such payments.
- Foreign exchange reserves also play a major role in protecting the value of the rupee. For example, if the rupee starts falling sharply against the dollar, the RBI may sell dollars from its reserves in the market and buy rupees.
- This increases the supply of dollars and helps stabilize the exchange rate. Recently, the RBI has used reserves to reduce volatility in the rupee during global tensions and oil price shocks.
- In simple terms, foreign exchange reserves act as the country’s economic shield and confidence booster. They help India continue imports during crises, repay external debt, stabilize the currency, and reassure investors that the country is financially strong
3. What is the foreign exchange reserves of India in 2026?
- The central bank introduced this ceiling at a time when the Indian rupee had slipped to a historic low of 94.81 against the US dollar, marking a depreciation of nearly 4 percent since the conflict began in late February.
- This measure was primarily intended to arrest the rupee’s slide by restricting the extent of foreign currency exposure that banks are allowed to hold within the domestic market.
- Moreover, as pressure on the domestic currency intensified, the Reserve Bank of India deployed dollars from its foreign exchange reserves to support the rupee and contain excessive volatility.
- Consequently, India’s forex reserves have declined by more than $30 billion, falling to around $698.34 billion since the onset of the conflict. This move reflects the central bank’s growing concern over exchange-rate instability and its efforts to prevent sharp and disorderly fluctuations in the currency market.
- Large-scale outflows by foreign investors have further intensified downward pressure on the rupee, causing it to breach the ₹92, ₹93, and now ₹94 per dollar levels within the same month.
- The currency had already weakened beyond the ₹90 and ₹91 marks in December 2025, and it is now hovering dangerously close to the ₹95 per dollar threshold, underscoring the severity of the ongoing external and financial pressures
4. What are the components of the foreign reserves of India?
- The largest component is Foreign Currency Assets (FCA). This forms the bulk of India’s reserves—usually around 80–85 percent. It includes assets held in major international currencies such as US dollars, euros, pounds, and yen.
- These are not just bundles of cash; most of them are invested in safe foreign assets such as US Treasury bonds, sovereign securities, deposits with foreign central banks, and commercial banks. This is the main pool the RBI uses when it wants to stabilize the rupee in the forex market.
- The second component is gold reserves. India holds a significant quantity of gold as part of its reserves. Gold acts as a store of value and a hedge during times of global uncertainty, inflation, or geopolitical tensions. Unlike paper currencies, gold retains intrinsic value and strengthens confidence in the country’s reserve position
- The third component is Special Drawing Rights (SDRs). These are international reserve assets created by the International Monetary Fund.
- SDRs are not a currency in themselves, but they can be exchanged for freely usable currencies like the US dollar. They act as an additional source of international liquidity for member countries.
- The fourth component is the Reserve Tranche Position (RTP) in the IMF. This refers to the amount India can immediately withdraw from the IMF without any conditions, based on its quota contribution to the Fund. It is like India’s readily available claim with the IMF
5. RBI Proposed Changes
- Bankers are showing growing concern over the proposed regulatory changes, as these measures could have immediate operational and financial implications. A key issue being raised is the pace of implementation.
- Several banks have requested the Reserve Bank of India to provide a transition period of nearly three months so that existing foreign exchange positions can be gradually reduced or restructured in an orderly manner.
- According to market analysts tracking the developments, sudden enforcement would leave limited scope for effective risk management and could result in avoidable losses.
- The magnitude of existing exposure has further heightened these concerns. Estimates suggest that individual banks currently hold significant dollar positions, making the cumulative exposure across the banking system quite large.
- If the revised limits are introduced without any transition period, banks may be forced to unwind these positions quickly, potentially leading to dollar sales worth nearly $11–15 billion across the sector, according to market assessments.
- Such rapid unwinding could also expose banks to mark-to-market losses, particularly if positions have to be exited at unfavourable exchange rates.
- These losses would be reflected in their treasury books for the ongoing March quarter, thereby exerting pressure on profitability and quarterly earnings.
- Market observers also note that if the rupee continues to weaken, the RBI may introduce additional measures to support the currency and preserve foreign exchange reserves.
- A similar approach was witnessed during the global financial crisis and the taper tantrum, when then RBI Governor Raghuram Rajan responded to pressure on the rupee by encouraging foreign currency inflows.
- One notable intervention was the FCNR(B) scheme, which offered subsidized swap rates and successfully attracted more than $30 billion, significantly strengthening India’s forex reserves
6. Way Forward
Market analysts suggest that if the rupee’s depreciation persists, the Reserve Bank of India may introduce additional policy measures to support the currency and protect foreign exchange reserves. A similar approach was seen during earlier episodes of financial stress. During the global financial crisis and the subsequent taper tantrum, when the rupee came under significant pressure, then RBI Governor Raghuram Rajan responded by encouraging foreign currency inflows into the country. One of the most notable interventions was the FCNR(B) scheme, which offered concessional swap rates and succeeded in attracting more than $30 billion, thereby substantially strengthening India’s foreign exchange reserves
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For Prelims: Current events of national and international importance
For Mains: General Studies III: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.
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Previous Year Questions
1.Which of the following has/have occurred in India after its liberalization of economic policies in 1991? (UPSC CSE, 2017)
1. Share of agriculture in GDP increased enormously. 2. Share of India’s exports in world trade increased. 3. FDI inflows increased. 4. India’s foreign exchange reserves increased enormously. Select the correct answer using the codes given below: (a) 1 and 4 only (b) 2, 3 and 4 only (c) 2 and 3 only (d) 1, 2, 3 and 4 Answer (b)
2. With reference to the Indian economy, consider the following statements: (UPSC CSE, 2022)
1. If the inflation is too high, Reserve Bank of India (RBI) is likely to buy government securities. 2. If the rupee is rapidly depreciating, RBI is likely to sell dollars in the market. 3. If interest rates in the USA or European Union were to fall, that is likely to induce RBI to buy dollars. Which of the statements given above are correct? (a) 1 and 2 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3 Answer (b)
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Source: The Hindu
