The Foreign exchange reserve is defined as a holding of other countries’ currencies that can be converted into its own currency through the foreign exchange market, as well as holdings of foreign assets in government securities, such as bonds, and gold, that can be easily turned into cash
Foreign currency reserves are also defined as foreign exchange reserves or forex reserves, or a collection of foreign currencies and other assets held by a country's central bank or monetary authority. These reserves are used to facilitate international transactions, maintain stability in the domestic currency, and manage various economic challenges
Reasons countries hold foreign currency reserves
Reserves are used to settle international trade and payments. When a country imports goods or services, it will pay in foreign currencies. Reserves provide the necessary funds to fulfill these obligations without putting excessive pressure on the domestic currency's value. Other reasons are as follows:
- Exchange Rate Stability: Reserves can be used to intervene in the foreign exchange market to stabilize the value of the domestic currency. If the domestic currency depreciates rapidly, the central bank can sell foreign currency from its reserves to buy back the domestic currency, which helps prevent excessive volatility and sharp declines in its value.
- External Debt Servicing: Many countries have external debt denominated in foreign currencies. Reserves can be used to make interest payments and principal repayments on these debts, ensuring that the government does not default on its obligations.
- Investment Opportunities: Some countries invest some of their foreign currency reserves in safe and liquid assets denominated in foreign currencies. These investments can generate income and provide a potential source of returns.
The common currency used as a foreign currency reserve.
The U.S. dollar is recognized as the foreign reserve currency of choice by many countries, and it tends to represent the largest foreign currency in holdings in proportion to other currencies such as the euro, the yen, and the pound.
However, according to the International Monetary Fund, since the start of the 21st century, central banks have been reducing the proportion of U.S. dollars as reserves to reduce reliance on a single currency and have been diversifying into currencies of other nations including the Australian dollar and Canadian dollar. In 1999, the average holding of U.S. dollars in countries’ foreign exchange reserves was about 70 percent. As of the second quarter of 2022, that was 59.5 percent, which is roughly $6.6 trillion of the $11 trillion of total reserves globally
What’s the condition of Indonesia's foreign currency reserve?
Indonesia’s foreign exchange reserves (forex) declined compared to the start of the year. The forex position for May 2024 stood at 139 billion USD, a decrease from the 140.4 billion USD recorded in March. The Indonesian Forex started at 145 billion USD on Jan 2024 and is now on its downtrend. The Bank of Indonesia has explained that the decrease in forex in April was due to BI's efforts to stabilize the rupiah exchange rate, which has recently been weakening.
Bank Indonesia stated that the reserves are expected to remain adequate, due to stable national economic conditions and coordinated policy efforts between Bank Indonesia and the Government to foster sustainable economic growth.