India’s forex reserves explained: What they are, who owns them, and how RBI uses them

Competitive Exam explainers | Indian economy

Why in the news?

India’s foreign exchange reserves jumped $7.26 billion to $674.193 billion during the week ended July 3, the Reserve Bank of India said on Friday. In the previous reporting week, the forex kitty had dropped by $5.654 billion to $666.933 billion. The kitty had expanded to an all-time high of $728.494 billion during the week ended February 27 this year before the onset of the Middle East conflict, which led to several weeks of a drop as the rupee came under pressure and the RBI had to intervene in the forex market through dollar sales. Prime Minister Narendra Modi has also made multiple public appeals starting May 11 to countrymen to conserve forex by cutting down on foreign travel, limiting fuel use and refraining from gold buys for a year.In this context, let’s understand what forex reserves actually are, who owns them, and when the RBI can dip into them.

The concept in simple terms

Forex reserves are the stock of foreign currency, gold, and other international assets that a country’s central bank holds to meet external payment obligations and to keep the domestic currency stable. Think of them as a nation’s emergency fund in foreign currency, used to pay for imports, service foreign debt, and defend the rupee if it comes under pressure.A common misconception is that these reserves are simply “government money” sitting idle. In reality, the RBI builds these reserves by buying foreign currency from the market using freshly created rupees. So while the reserves are a national asset, they also sit against a rupee liability on the RBI’s own balance sheet. This is why the RBI, not the finance ministry, decides how and when reserves are deployed, and why they cannot simply be transferred to the government to fund the budget.

How it works

India’s forex reserves have four components:

The RBI accumulates these assets through market intervention (buying dollars when there is excess inflow), interest income on existing reserves, and funding from multilateral bodies. It draws them down mainly to sell dollars when the rupee depreciates sharply, smoothing volatility rather than defending a fixed target.

Key institutions and legal framework

India’s context

India holds among the largest reserve stockpiles globally, positioning it well behind China but among the top holders worldwide, giving it a comfortable import cover. Meanwhile, the RBI’s revised FCNR-B deposit scheme is expected to attract $40-50 billion in fresh deposits, with banks intensifying outreach to NRI customers. The banking industry has mobilised an estimated $3-4 billion through FCNR-B deposits so far. This scheme, aimed at non-resident Indians, is one of the tools the RBI is using to rebuild reserves after the dip caused by the Middle East conflict and related rupee pressure. Historically, reserves have played a decisive role in past crises, most notably 1991, when India had to pledge gold to raise emergency loans, and 2008, when reserves cushioned the global financial crisis without needing an IMF bailout. FACTBOX

Mains practice question: “Foreign exchange reserves are a national asset but also a central bank liability.” Discuss this statement with reference to the composition and management of India’s forex reserves, and examine the limits on their use for fiscal purposes.

Test yourself

Q1. Which of the following are components of India’s forex reserves?

Select the correct answer:(a) 1, 2 and 3 only(b) 1 and 4 only(c) 2 and 3 only(d) 1, 2, 3 and 4Answer: (a)Q2. The Reserve Tranche Position refers to:(a) India’s gold holdings with the World Bank(b) The portion of India’s IMF quota accessible without conditions(c) A loan taken by India from the IMF(d) India’s foreign debt to other nationsAnswer: (b)Q3. Which law primarily governs foreign exchange transactions in India today?(a) FERA, 1973(b) RBI Act, 1934(c) FEMA, 1999(d) Banking Regulation Act, 1949Answer: (c)Q4. The largest component of India’s forex reserves by value is:(a) Gold(b) Special Drawing Rights(c) Foreign Currency Assets(d) Reserve Tranche PositionAnswer: (c)Q5. The RBI primarily uses forex reserves to:(a) Fund the union budget directly(b) Intervene in the currency market and stabilise the rupee(c) Pay government employee salaries(d) Finance state government schemesAnswer: (b)

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