FOREIGN EXCHANGE RESERVES ADEQUACY NORMS

FOREX adequacy norms UPSC

FACTORS THAT AFFECT FOREX ADEQUACY NORMS

FOREIGN EXCHANGE RATE ADEQUACY NORMS

FOREX RESERVE requirements vary from country to country depending on the system of governance, exchange rate policy, size, composition of the economy, trade pattern, etc.

Let us understand the above issues:

  • System of governance – if a country runs on socialistic lines, it will try to remain aloof from global trade, but in modern times most countries with only a few exceptions have adopted some level capitalism
  • Exchange rate policy – if a country is socialistic in governance, it will have government control, this can lead to less freedom and a highly managed & controlled exchange rate regime
  • Size of the country – If a country is big in terms of population, it will require high reserves to tide over uncertain times.
  • Composition of the economy – Where a country gets it’s GDP from, defines its trade participation, which in turn affects the economic policy i.e. closed or open. A manufacturing and service based economy will want to export more & hence will prefer easier less controlled exports, whereas poor or less developed countries will prefer less trade.
  • Trade pattern – more diversity in destination and number of commodities in trade, less the need to have high reserves.

More the reserve, more the convertibility & eventually more foreign direct investments:

Once a country has adequate reserves, it can allow convertibility, which can in turn bring in more investments.

What amounts to safe FOREX reserves?

FOREIGN EXCHANGE RESERVES NORMS

According to a generally accepted  principle, Forex equivalent of 12 months of payment obligations can be generally considered safer. That would mean forex reserves should be more than sum total of 12 months of imports and all payment obligations like foreign debt, etc,.

India for years has debated fully convertible currency mechanism that means on capital and current account but inadequate reserves has led to postponement of this decision.

In December 2023 – Indias yearly imports amount to US$ 900 billion and reserves are only US$ 615 billion, equivalent to 8 months of imports. India has US$ 630 billion of external debt, 10% of this is yearly obligation to repay, normally.

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