Foreign exchange reserves are the assets of central bank and other monetary authorities in the form of US dollar, pound, euro and Japanese yen. Foreign exchange reserves are also called the reserves assets and it is used to pay back its liabilities, e.g. local currency issued and various bank reserves deposited with the state bank by government .Before the end of gold standard it was kept only in the form of gold only. The reserve assets can be categorized as gold reserve, Unallocated gold reserve, Special drawing rights, currency, Reserve position in the IMF, other transferable deposits, other deposits, debt securities, loans, investments, fund shares and financial derivatives. The quantity of foreign exchange reserves can change the central bank monetary policy but this dynamics is analyzed in the context of the exchange rate .
If central bank implements a fixed exchange rate then supply and demand would tend to push the value of the currency lower or higher e.g. an increase in demand for the currency would increase the value and decrease lower and thus the central bank use reserves to maintain its fixed exchange rate.
"The rate which one currency will be exchanged for another."
Exchange rate affects the foreign exchange reserves and it is adjusted according to the market demand. With the help of exchange rate local currency is adjusted so that it does not create inflation or deflation in the country.
FACTORS AFFECTING FOREIGN EXCHANGE RESERVES FROM 1980 TO 2010
In 1980 there was high foreign exchange reserve. Both exports earnings and home remittances increase beyond the expectations. IMF provides extent fund facility arrangements. In 1981 due to world recession there was crash in the demand, the appreciation of US dollar and slowdown in the home remittances. Exports were reduced due to dollar appreciation there was increase in foreign exchange reserve. In 1982 there were... [continues]
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