Mains Marathon

Approach:

• Begin by defining foreign exchange reserves and explaining their role in macroeconomic stability.
• In body, examine their benefits as well as associated risks or limitations, using relevant data and examples.
• Conclude suitably.

Introduction:

India’s foreign exchange reserves touched an all-time high of $704.88 billion in September 2024. As of April 2025, foreign currency assets, a key component, rose by $892 million to $574.98 billion, underscoring India’s growing external buffer. These reserves play a vital role in ensuring macroeconomic stability, especially amid rising global economic uncertainties.

Body:

Role of Forex Reserves in Macroeconomic Stability:

• Acts as a shock absorber during global volatility by ensuring currency stability and investor confidence.
  • Example: During the COVID-19 pandemic and Russia-Ukraine war, India used reserves to manage rupee volatility.
• Strengthens external sector resilience by ensuring import cover and meeting debt obligations.
  • India’s reserves cover over 11 months of imports and provide a buffer against balance of payments crises.
• Improves sovereign credit ratings and reduces the cost of foreign borrowing.
  • High reserves signal a strong macroeconomic position, enhancing credibility with global investors and credit agencies.
• Facilitates exchange rate management and controls excessive rupee depreciation or appreciation.
  • The RBI (Reserve Bank of India) intervenes in forex markets using reserves to prevent disorderly currency movements.
• Supports confidence in monetary and fiscal policy by enabling stable inflation and interest rate environments.
  • Reserves help in maintaining adequate liquidity and stabilizing capital flows in volatile periods.

Limitations and Challenges of Rising Forex Reserves

• Opportunity cost of holding low-yield assets abroad rather than investing in domestic infrastructure.
  • Most reserves are held in low-return US Treasury bonds and not in productive domestic assets.
• Sterilization of reserve accumulation leads to higher fiscal costs and monetary management complexities.
  • Managing excess liquidity requires issuing bonds, which increases public debt and affects interest rate control.
• Excessive reserves may reflect a defensive rather than productive economic strategy.
  • Overdependence on reserve accumulation may mask underlying structural trade or current account weaknesses.
• Volatility in global capital flows may still impact reserves sharply.
  • For instance, RBI used $70 billion of reserves in 2022 to defend the rupee during capital flight episodes.

Conclusion:

While India’s growing foreign exchange reserves have undoubtedly enhanced its macroeconomic stability, they are not a panacea. Prudent reserve management, structural reforms to boost exports, and reducing import dependency are essential for long-term resilience and sustained economic growth.