Reserve could be defined as external assets that are readily available to and controlled by monetary authorities for direct financing of external payments imbalances, for indirectly regulating the magnitudes of such imbalances through intervention in exchange markets to affect the currency exchange rate, and/or for other purposes. The ‘reserves’ refer to both foreign reserves in the form of gold assets in the Banking Department and foreign securities held by the Issue Department, and domestic reserves in the form of ‘bank reserves’.
Central Banks hold Foreign Exchange Reserves for the following reasons.
- It facilitates to intervene in the Forex market to ensure orderliness.
- For the emerging economies Reserves act as bedrock of investors’ confidence in the country’s ability to meet its foreign exchange commitments.
- Maintaining confidence in monetary and exchange rate policies
- limiting external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis including national disasters or emergencies
The blend and ordering of these reasons will, however, depend on country-specific factors, such as the country’s exchange rate regime, its credit worthiness and its degree of vulnerability to external shocks as well as the range of domestic instruments available for monetary operations. Even for the same central bank, the ordering can vary depending upon the macroeconomic and financial market conditions
Central Banks hold gold as their part of reserves according to their own policies .most of central banks prefer to hold gold in their own countries but some situations forced them to move their gold outside for example in the condition of any crisis or war type of situation
Central Banks hold gold as their foreign exchange reserve because of the following reasons:
- Gold is universally acceptable
- Safety and Liquidity considerations
- Gold a good Diversifier
- Movement in Gold Price vs. US Dollar
- It is used to hedge against currency and inflation risks.
RBI, the Central Bank of India traditionally parked its gold reserve in its vaults. However in1991, it kept its pledged gold with the bank of England .Moe recently in 2009, it bought gold from the IMF in decentralized form. In mid 1970s, RBI held around 20-25% of the total foreign reserves in form of gold and it ranges between 5% and 12% till 1989 -90. Now, RBI’s gold holding is less than 10% of its reserve.