Which of the following statements is/are correct? 1. Most of India's reserves is held in the form of foreign currency. 2. There is no cost of holding foreign currency as reserves by a nation. Select the correct answer using the code given below.
- (a)1 only
- (b)2 only
- (c)Both 1 and 2
- (d)Neither 1 nor 2
Correct — A, 1 only. Statement 1 matches how the reserves are actually built. The Economic Survey sets out the four components in one sentence — India's foreign exchange reserves comprise foreign currency assets, gold, special drawing rights and the reserve tranche position in the IMF — and foreign currency assets are much the largest of the four, which is why the Survey singles them out when it explains a change in the total. Statement 2 is the one to reject. Reserves are not free. The money is parked in safe, liquid, low-yielding foreign instruments such as sovereign paper and deposits with other central banks, while the country's own borrowing carries a higher interest rate, so the gap between the two is a real carry cost. On top of that, when the central bank buys dollars it releases rupees into the system and has to absorb them again, and that mopping-up has a price of its own. A nation holds reserves knowing all this, because insurance against an external shock is worth paying for — but the payment exists.
- (b)2 only — Reverses both judgements. It denies the composition of India's reserves, which really is dominated by foreign currency assets, and it accepts a costless-reserves claim that no central bank makes.
- (c)Both 1 and 2 — Statement 1 is sound, but 'no cost' is not. Holding reserves means accepting a lower return than the same capital could earn, which is the definition of an opportunity cost.
- (d)Neither 1 nor 2 — Throws away a correct statement. Foreign currency assets are the largest of the four reserve components by a wide margin, so statement 1 stands.
Foreign exchange reserves are external assets a central bank holds and can use at short notice to meet balance-of-payments needs and steady the currency. In India they are held by the Reserve Bank in four forms — foreign currency assets, gold, special drawing rights allotted by the IMF, and the reserve tranche position, which is the country's own quota money at the Fund. The management objective is safety first, liquidity second and return last, and that ordering is exactly why a holding cost is accepted.
Statement 2 is the kind of absolute claim that should trigger suspicion on sight; in economics almost nothing is costless. The cost of reserves is not a fee anyone pays but an opportunity cost, and that is a distinction worth being able to explain in an interview. Anchor the numbers to the exam year and then update them. Around the time of this paper India was carrying reserves in the region of USD 640 billion; the Survey records that they crossed the USD 700 billion mark later in 2024 before moderating to USD 640.3 billion at the end of December 2024, that this covered roughly 90 per cent of external debt, and that the import cover stood at 10.9 months against the IMF's suggested three. India ranked fourth in the world on reserve holdings in 2024, after China, Japan and Switzerland. The Reserve Bank publishes the figure weekly, so any number attached to this topic needs a date attached with it.
- India's reserves comprise foreign currency assets, gold, SDRs and the reserve tranche position in the IMF.
- Foreign currency assets are much the largest component of the four.
- Reserves stood at USD 640.3 billion at the end of December 2024, after crossing USD 700 billion earlier that year.
- That cover was about 90 per cent of India's external debt and 10.9 months of imports, against the IMF's three-month norm.
- Reserve management runs on safety, then liquidity, then return — so a return is deliberately given up.
- Accepting an absolute claim such as 'there is no cost' without asking what is being given up.
- Thinking of gold as the main form in which reserves are held, when foreign currency assets dominate.
- Quoting a reserves figure with no date — the Reserve Bank publishes the series weekly and it moves.
Asked as a two-statement code item where one statement is a factual composition point and the other is an absolute claim that fails on opportunity cost.
Consider the following statements: 1. During the year 2004, India's foreign exchange reserves did not exceed the 125 billion U.S. Dollar mark. 2. The series of index numbers of wholesale prices introduced from April, 2000 has the year 1993-94 as base year. Which of the statements given above is/are correct?
- (a) 1 only
- (b) 2 only
- (c) Both 1 and 2
- (d) Neither 1 nor 2
Answer(b) 2 only
The same subject twenty years earlier, and a useful scale check. India's reserves crossed USD 125 billion during 2004, which is why that statement failed; by the end of December 2024 they stood at USD 640.3 billion. It also shows how quickly a reserves number goes stale, which is why the CDS item here asks about composition and cost instead of a figure.
- practice — not a real PYQ
Which one of the following is NOT a component of India's foreign exchange reserves?
- (a)Foreign currency assets
- (b)Gold
- (c)Special drawing rights
- (d)Government of India dated securities held by banks
Answer(d) Government of India dated securities held by banks — reserves are external assets; the other three, along with the reserve tranche position, are the four components.
- practice — not a real PYQ
'Import cover' of foreign exchange reserves refers to
- (a)the share of imports paid for in foreign currency
- (b)the number of months of imports the reserves could finance
- (c)the customs duty collected on imports
- (d)the proportion of reserves held in gold
Answer(b) the number of months of imports the reserves could finance — the IMF suggests at least three months for emerging economies.