Foreign Exchange Reserves: Meaning, Composition,Purpose and Benefits

Foreign exchange reserve is consists of foreign currency assets, gold, Special Drawing Rights (SDR), and reserve position in the IMF. The total size of the Indian foreign exchange reserve was US$ 487039 million in May 2020.

What is the meaning of Foreign Exchange Reserves?

Foreign exchange reserves are assets like foreign currencies, gold reserve, SDR, and deposits with IMF, treasury bills, bonds, and other government securities.

This reserve is held to provide back up support to the government liabilities like; various bank reserves deposited with the central bank by the government or financial institutions and issuance of local currency by the Central Bank.  RBI is the custodian of the Foreign exchange reserves in India.

Most foreign exchange reserves are held in U.S. dollars, while China being the largest foreign currency reserve holder in the world. Its forex reserve was US$ 3,091,459 million (US$ 3 trillion) followed by Japan with US$ 1,368,567 million. It sounds good that India is in the top 5 countries. See the table below,

List of countries with the highest Foreign Exchange Reserve:-

Rank	Country	Foreign exchange reserves(millions of US$)
1.	China	3,091,459
2.	Japan	1,368,567
3.	Switzerland	823,765
4.	Russia	562,900
5.	India	487,039
6.	Taiwan	481,782
7.	Saudi Arabia	474,171
8.	Hong kong	441,200
9.	South Korea	404,000
10.	Brazil	339,317

Composition of Foreign Exchange Reserves:-

Foreign exchange reserve is composed of foreign currency assets, gold, Special Drawing Rights (SDR), and reserve position in the IMF. The total collection of the Indian foreign exchange reserve was US$ 487039 million. This total collection has a combination of the above-mentioned items.

As of 15 May 2020; the total reserve of the Indian foreign exchange reserve was US$ 487039 million or US$ 487 billion.

The biggest contributor in this reserve is foreign currency assets i.e. US$ 448670 million followed by the gold (US$32906 million), SDR of US$ 1425 million, and reserve with the International Monetary Fund (IMF).

Indian Foreign Exchange Reserve is as follows;

Purpose and Benefits of the Foreign Exchange Reserve:-

1. Foreign exchange reserves serve many purposes but the most significant objective behind its holding is to ensure that a central government agency (RBI in India) has backup funds if their national currency rapidly devalues or becomes all together insolvent.

2. Foreign exchange reserves are also used to influence monetary policy. If the value of domestic currency decreases due to an increase in demand of the foreign currency then the central government of India or other countries sells the dollar in the Indian money market so that depreciation of Indian currency can be checked.

3.  A country with a good stock of foreign exchange has a good image at the international level because the trading countries can be sure about their payments. India was on the brink of declaring defaulter at the international level during the 1991 financial crisis.

4. A country with good forex reserves attracts a good chunk of foreign trade and earns faith in trading partners.

Other information about the Foreign exchange reserves:-

1. Most foreign exchange reserves are held in U.S. dollars because it is the most traded currency in the world.

2. China has the world highest Foreign exchange reserves i.e. US$3.1 trillion 

3. It is quite surprising that the USA has a forex reserve of just US$ 129,264 million in March 2020.

4. India has the fifth largest forex reserve in India.

(This picture has a bit old data)

5. Indian forex reserves had touched a life-time high of USD 487 billion on March 6, 2020.
Economists think that it’s better to hold foreign exchange reserves in a currency that is not directly connected to the country’s domestic currency.

Foreign exchange reserve is like the health meter of an economy. if a country has a good chunk of forex reserve its financial condition is assumed to be very sound at the international level. 
So this was the crux of information on the Foreign exchange reserves. We hope that reader must be aware of the Meaning  Composition Purpose and Benefits of the Foreign exchange reserves.