The foreign currency reserve is a metric to judge a nation’s economic well-being. Any drop in foreign currency reserve indicates the falling ability of a country to pay for its critical imports.
Countries utilize their foreign currency reserves to maintain a fixed exchange rate for their currencies. China is an excellent example since its currency, the yuan, is pegged to the dollar. When China accumulates dollars, it increases the dollar’s value relative to the yuan. This reduces the cost of Chinese exports relative to those manufactured in the United States, hence boosting sales. Here is a quick overview of the recent foreign exchange reserve data as published from various sources.
|Rank||Country||Foreign Exchange Reserve (USD Billion)|
Thus, the foreign exchange reserve of the top three countries can be counted as trillion, the rest will fall in the range of $4 – $6 billion. China is far ahead of the rest and if we add Hong Kong with China, it goes much beyond. Alternatively, sum up the foreign currency reserves excluding the top 3 and Hong Kong. Now match the sum with China. Interesting data points for analysis!
What are the benefits of holding higher foreign currency reserves? Here is a quick summary.
- Countries with a floating exchange rate system use reserves to maintain their currency’s value below the dollar’s. They do so for the same reason that fixed-rate systems do. Even though Japan’s currency, the yen, is a floating currency, the Central Bank of Japan purchases US Treasury bonds to maintain the yen’s value below that of the dollar. As with China, this helps keep Japan’s exports affordable, encouraging trade and economic development.
- A third crucial duty is to preserve liquidity in the event of an economic downturn. This depletes their foreign currency reserves for imports. In such instances, the central bank may convert their foreign cash to local currency, enabling them to pay for and receive imports.
- A fourth reason is to instill trust. Foreign investors are assured that the central bank is prepared to take steps to safeguard their assets. Additionally, it will prevent a rapid flight to safety and a consequent loss of cash for the nation.
- Reserves are always required to ensure that a country’s foreign commitments are met.
- Countries utilize their reserves to finance infrastructure plans and projects. China, for example, has utilized a portion of its foreign exchange reserves to recapitalize several state-owned banks.
India’s forex reserves reported $631.5 million by March first week 2022, much lower than as reported in Sep 2021. The forex reserves are comprised of foreign currency assets (FCAs), gold reserves, Special Drawing Rights (SDRs), and the country’s reserve position with the International Monetary Fund (IMF). The foreign exchange reserve for the past two years has been compiled on a quarterly basis, per the RBI bulletin.
FCA are assets that are valued based on a currency other than the country’s currency. FCA accounts for the lion’s share of the Indian FX reserve. It is denominated in dollars. However, FCA considers the impact of appreciation or depreciation of non-US currencies held in foreign exchange reserves, such as the euro, pound, and yen. Currency appreciation is the process through which the value of one currency increases compared to another in the forex markets. In a floating exchange rate system, currency depreciation is the decrease in the value of a currency. In a floating exchange rate system, market forces (based on a currency’s demand and supply) decide the currency’s value.
Here is a question – Do we need to focus on building up foreign currency reserves? or does the economic boom result in burgeoning foreign currency reserves?
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