In the current year, the global foreign currency reserves fell by around $1 trillion to $12 trillion. It is the biggest drop since 2003. The reserves still continue to fall.
These reserves are maintained by the central banks of countries across the world. For instance, the reserves in India are maintained by RBI.
Central banks use it to maintain stability in the exchange rate. In case of depreciation in currency value, then central banks start selling dollars to prevent a further drop in value.
Why world currency reserves are falling?
The main reason behind the fall in the world currency reserves is the Fed’s decision to hike interest rates to combat inflation.
In the past few months, Fed increased the interest rate multiple times and in order to stop the depreciation of the local currencies, respective central banks start taking the help of their currency reserves.
India’s currency reserve, for example, has fallen by nearly $96 billion to around $538 billion. Despite a fall in the reserve, the rupee lost 9 percent against the dollar this year.
Still, India’s currency reserve is 49 percent higher than the 2017 level.
Central banks use currency reserves to manage appreciation, depreciation of local currencies
The central banks use currency reserves to manage the appreciation and depreciation of local currencies by buying and selling dollars respectively.
When the market is in a boom period, local markets across the world see a rise in the inflow of dollars in the form of foreign investments. In such a scenario, the central bank of the respective country starts buying dollars to avoid appreciation of the currency.
In the case of a bust period, the same markets witness outflow of dollars as investors will start withdrawing their investments. In that case, the central bank of the respective currency starts selling dollars from their currency reserve to compact the depreciation of the currency.
