“India’s Forex Reserves: Gauging Economic Strength and Stability”

India’s foreign currency reserves reached a record high in September 2024, but since then it has declined by almost $80 billion. Do we have enough?

How much did the foreign exchange reserves go up after the pandemic? And why did it fall again?

After the COVID-19 pandemic, global foreign exchange (forex) reserves experienced significant fluctuations.

Here’s an overview:

1. Record Highs:

Global forex reserves reached an all-time high of approximately $12.7 trillion in 2021, reflecting a surge in accumulation by central banks worldwide.

2. Reasons for the Increase:

Export Recovery:

As global trade rebounded after the pandemic-induced downturn, countries with trade surpluses (such as China and several Asian economies) accumulated reserves.

Quantitative Easing (QE):

Central banks in advanced economies, particularly the U.S. Federal Reserve, engaged in massive monetary stimulus programs. This created global liquidity, much of which flowed into emerging markets, boosting their reserves.

Capital Inflows:

High global liquidity and low-interest rates in developed markets led to increased capital inflows into emerging markets, further increasing their forex reserves.

Currency Interventions:

Some central banks actively intervened in foreign exchange markets to maintain currency stability, leading to reserve growth.

Why Forex Reserves Have Fallen Again By late 2022 and into 2023, global forex reserves began to decline. Key reasons include:

1. Interest Rate Hikes:

The U.S. Federal Reserve and other major central banks raised interest rates to combat inflation, leading to capital outflows from emerging markets back to developed economies.Higher interest rates strengthened the U.S. dollar, devaluing non-dollar assets held in reserves.2. Currency Interventions:To stabilize their currencies amid a stronger dollar and capital outflows, many central banks used their reserves to intervene in foreign exchange markets. For example, India, Japan, and South Korea sold dollars to support their local currencies.

3. Declining Trade Surpluses:

Slower global trade growth in 2023 reduced export revenues for many countries, limiting their ability to build reserves.

4. Asset Valuation Losses:

A significant portion of reserves is held in government bonds, particularly U.S. Treasuries. Rising interest rates reduced the market value of these bonds, leading to a decline in reserve valuations.

5. Geopolitical Risks:

The Russia-Ukraine war and associated sanctions led to significant reserve adjustments. Russia, for instance, shifted reserves away from U.S. dollars to other currencies like the yuan and gold. Other countries also reconsidered reserve allocation to reduce geopolitical risks.

Conclusion

The rise and fall of forex reserves post-pandemic reflect the shifting dynamics of global trade, monetary policy, and geopolitical events. While reserves remain critical for currency stability and economic resilience, their fluctuations underscore the interconnectedness of global markets and the challenges of managing them in an uncertain economic environment.