Ramesh Singh Test : External Sector In India - UPSC

• The total foreign currencies (of different countries) an economy possesses at a point of time is its foreign currency assets/reserves".

• The Forex Reserves (short for foreign exchange reserves) of an economy is its 'foreign currency assets' added with its gold reserves, SDRs (Special Drawing Rights) and Reserve Tranche in the IMF.

• In a sense, the Forex reserves are the upper limit up to which an economy can manage foreign currency in standard times if need be.

• While forex reserves act as insurance when the rupee tends to be volatile against the dollar, there are costs attached to it. When RBI purchases dollars in the spot, it leads to infusion of rupee into the system which leaves an inflationary effect on the economy.

• Since the RBI does not want such actions to create inflationary pressure, it converts spot purchases into forwards.

• This way, it is a direct cost because of the forward premiums. If RBI opts for open market operations (OMOs) to mop up excess liquidity, that also involves costs.

In the floating exchange rate system, a domestic currency is left free to float against several foreign currencies in its foreign exchange market and determine its value. Such exchange rates are regulated by factors such as demand and supply of the domestic and foreign currencies in the concerned economy.

• A managed-exchange-rate system is a hybrid or mixture of the fixed and flexible exchange rate systems.

• Government of the economy attempts to affect the exchange rate directly by buying or selling foreign currencies or indirectly, through monetary policy" (i.e., by lowering or raising interest rates on foreign currency bank accounts, affecting foreign investment, etc.).

• Some economies, particularly small ones, peg their currencies to a major currency or a basket of currency in a fixed exchange rate-known as the pegging of currencies.

• At times, the peg is allowed to glide smoothly upward or downward-a system, which is known as gliding or crawling peg. Some economies have a hard fix of a currency board.

• TRADE BALANCE: The monetary difference between the total export and import of an economy in one financial year is called trade balance. It might be positive or negative, known to be either favourable or unfavourable, respectively to the economy.

• TRADE POLICY: Broadly speaking, the economic policy which regulates the export-import activities of any economy is known as the trade policy. It is also called the foreign trade policy or the Exim Policy. This policy needs regular modifications depending upon the economic policies of the economies of the World or the trading partners.

• In the foreign exchange market, if a free-floating domestic currency increases its value against the value of a foreign currency, it is appreciated.

• In the domestic economy, if a fixed asset has seen an increase in its value it is known as appreciation.

• Any government does not set appreciation rates for different assets as they depend upon many unseen factors.

• Every Government of the World maintains a capital account, which shows the capital kind of transactions of the economy with outside economies.

• Every transaction in foreign currency (inflow or outflow) considered as capital is shown in this account-external lending and borrowing, foreign currency deposits of banks, external bonds issued by the Government of India, FDI, PIS and security market investment of the QFIs (Rupee is fully convertible in this case).

• There is no deficit or surplus in this account like the current account.

• In the external sector, it refers to the account maintained by every Government of the World in which every kind of current transaction is shown—basically this account is maintained by the central banking body of the economy (RBI in case of India) on behalf of the Government.

• India had surplus current accounts for three consecutive years (2000–03) the only such period in Indian economic history.