What is Foreign Exchange Reserve?
Foreign Exchange Reserve also referred to as Forex reserve or FX reserve, are the assets that are held by the Central bank of a country on reserve in the form of foreign currencies. The reserves include foreign banknotes, deposits, bonds, treasury bills, and other government securities. These reserves are mainly used as a backup for liabilities. Another essential feature of the Forex exchange reserve is that it profoundly influences the monetary policy. When the nation’s currency falls significantly, the Forex reserves play an important role as a backup. Most of the countries hold US dollar as reserves because it is the most traded currency in the world. The other conventional currencies include British pound (GBP), Chinese yuan (CNY), the Euro area’s euro (EUR), and the Japanese yen (JPY).
Accumulation of Foreign Exchange Reserve
Suppose there are two countries, namely country A and country B. Let us assume that the value of A and B’s currency is the same initially and have a very stable exchange rate. Now, for whatsoever reason, people start believing that B is an excellent place to invest. They want to invest in B’s real estate and its stock market. So, there will be supply in A’s currency while a huge demand in B’s currency. And, the value of B’s currency will become very expensive. Looking at A’s perspective, you will have to pay more A’s currency per B. Contrarily, in B’s perspective you’ll have to pay less B’s per A. Assuming, the Central Bank of B does not like its currency getting stronger. Maybe, they don’t like the volatility and the dramatic moves in the market. So, what the Central bank does is, they start printing more of their currency, and with that extra currency of theirs, they buy A’s currency. By doing so, the demand and supply for B would be sort of stabilized. Looking on the other side, the Central bank will have A’s currency in its balance sheet. To put it in a nutshell, what actually happened is, one country printed its own currency and went on to buy another country’s currency. There might be several reasons to do so. The example mentioned above is just one of them. Hence, this sums up the accumulation of Forex reserves in a Central bank.
Why is Foreign Exchange Reserve important?
Foreign Exchange Reserve can prove to be helpful for the following reasons below.
- A good amount of Foreign Exchange Reserve increases the confidence in the monetary and exchange rate policy of the government.
- As discussed in the above example, it helps in controlling any adverse movement in the Forex market also stabilizes the currency rates for a favourable economic environment for the country’s progress.
- During the currency crisis of a country, Foreign Exchange Reserves can be a handy tool in resolving the crisis.
- When a country has a considerable amount of Foreign Exchange Reserves, the foreign investors can more reliably look forward to investing in the country’s market as they are backed with a good amount of Foreign Exchange Reserves.
- Another vital function is to maintain liquidity during an economic crisis. For example, during a financial crisis in a country, it would not be able to produce the required amount of goods for exporting and hence, they cannot receive their imports as well, because of the cut off in supply of foreign exchange. In such a case, the Central bank exchanges its foreign currency for their local currency and receives the imports.
A reliable source of information on Foreign Exchange Reserve
There are many websites that provide data on Foreign Exchange Reserves by different countries. It is usually measured in the country’s currency unit. The following links will provide a detailed view of the current Foreign Exchange Reserve, historical data, highest and lowest during a period, chart representation, statistics, etc. of different countries.
What do traders care about Foreign Exchange Reserve, and what are its impacts on the currency?
The Foreign Exchange Reserve numbers are important to traders and investors as it controls the demand and supply in the Forex market. Let us understand its role in the Forex market with the help of an example. Let’s say the USA is pouring huge lumps of cash to buy Indian based goods, bonds, etc. There would be a massive demand in the Indian market. The value of USD/INR would fall from 70 to a value 60. In other words, the value of USD would decrease, and the value of INR would rise. The Central bank can then intervene this and buy back the dollar from them, which can increase their Forex reserve value and also maintain the value of USD/INR around 70 again. Hence, traders and investors can take advantage after knowing that Central banks are going to buy back the USD.
Frequency of Release
Just like most of the other economic indicators, the frequency of release of the Foreign Exchange Reserve numbers is usually one month. For example, in major countries like the USA, UK, Switzerland, New Zealand, Japan, the Euro area, Canada, and Australia, the numbers are released on a monthly basis. The release date might vary from each country, but the frequency by month remains the same. The reports can be accessed by the links provided above.
Foreign Exchange Reserves are assets held by the Central banks or other monetary authority in various reserve currencies. The primary purpose of holding these reserves is to make international payments hedge against exchange rate risks. It is also an essential tool in stabilizing the country’s currency value. With the help of Foreign Exchange Reserves, a country can always maintain its currency value. Therefore, to an extent, it also keeps the economy of a nation intact and proves to be an important economic tool.