Foreign exchange reserves are also called Forex reserves and are the amount of foreign currency deposits that a country’s central bank holds.
The foreign exchange reserves of the country consist of foreign currency assets held by the RBI, gold holdings of the RBI and SDRs.
The foreign exchange reserves, also referred as Forex are foreign exchange currency and bonds that are held by any central bank and monetary authorities of a country.
Foreign exchange reserves are maintained as a multi-currency portfolio comprising major currencies, such as, US dollar, Euro, Pound sterling, Japanese yen, etc. and are valued in terms of US dollars.
RBI functions as the custodian and manager of forex reserves.
The Foreign exchange reserves of India consist of below four categories.
 Foreign Currency Assets (FCA)
 Special Drawing Rights (SDR)
 Reserve Tranche Position in the IMF
FCA Foreign Currency Assets excludes—
[a] investment in bonds issued by IIFC (UK)
[b] SDR holdings of Reserve Bank, which is included under SDR and
[c] amount lent to Sri Lanka under SAARC Swap and Special Currency Swap Arrangement.
Sources of Variation in Foreign Exchange Reserves
 Foreign Investment— Foreign Direct Investment (FDI), Portfolio Investment, Foreign Institutional Investment (FII)
 Banking Capital— NRI Deposits
 Short term credit
 External Assistance
 External Commercial Borrowings
Importance of Foreign Exchange Reserves—
 Forex reserves are instruments to maintain or manage the exchange rate, while enabling orderly absorption of international money and capital flows.
 Forex reserves maintain confidence in monetary and exchange rate policies.
 Forex reserves enhance capacity to intervene in forex markets.
 Forex reserves limit external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis including national disasters or emergencies.
 Forex reserves provide confidence to the markets especially credit rating agencies that external obligations can always be met, thus reducing the overall costs at which forex resources are available to all the market participants.
 Holding of currencies of other countries has a positive impact in terms of keeping the country’s currency stable and reducing of economic shocks.
 Forex reserves are used as making the import payments, paying of the interest, paying back the advances and repatriation of investments and earnings.