Explained: What is forex reserve and why is it so important for countries?

Forex Reserve often hits headlines even when it increases or decreases. According to the Reser Bank of India data, India's forex reserves swelled by US dollars 6.561 billion to reach US dollar 531.081 billion for the week ended October 28. The overall reserves had dropped by US dollars 3.847 billion to US dollars 524.52 billion in the previous reporting week. In October 2021, the country's forex kitty had reached an all-time high of US dollars 645 billion. The forex reserves were declining as the RBI deploys the kitty to defend the rupee amid pressures caused by global developments. Foreign currency assets (FCA), a major component of the overall reserves, jumped by USD 5.772 billion to USD 470.847 billion during the week of October 28, according to the Weekly Statistical Supplement released by the RBI yesterday.

What is Forex Reserve?

Forex reserve or foreign currency reserves include cash (foreign currency) and other assets like gold that are held by the central banks of any country or other financial institutions like the International Monetary Fund (IMF). 

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Why do countries keep forex reserves?

Countries keep foreign cash with themselves for various reasons. According to the World Economic Forum, keeping a reserve of foreign cash helps countries in times of economic crisis as well as helps them maintain the stability of their domestic currencies. Some of the reasons are listed below:

* Value of a domestic currency: Every country's domestic currencies are compared with the US dollar. So, if China stockpiles the US dollar, it does so it raises the dollar value versus the yuan, thereby making Chinese exports cheaper which promotes the sale of Chinese goods.

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* Liquidity at times of economic crisis: In case of an economic crisis, if a central bank has a forex reserve, it can exchange that for the local currency to ensure that domestic companies can continue to import and export competitively. Exchanging forex reserves with local currency helps keep the local currency's value high.

* Foreign investors: When a war or internal unrest breaks out, it often spooks investors and they look to move their money out of the country. So, when a country keeps a lot of forex reserves, it boosts investors' confidence and calms their fears.

There are many other reasons for which a country keeps forex reserves and it includes meeting international financial obligations, funding big infra projects, and diversification of portfolio. 

(With PTI inputs)