Forex exchange reserves which are also known as foreign currency reserves or foreign reserves are the foreign assets reserved by or held by central bank of a country. Foreign exchange reserves are actually used to replace liabilities or serves as a backup of liabilities. It is also a factor in determining monetary policy. The reserved assets are banknotes, the commercial paper called treasury bills, deposits, debentures, shares, stocks of government bonds which is also known as bonds and all other forms of securities trading in the market or government securities. It is not uncommon for the central bank of a country to hold or reserve assets for foreign exchange.
This reservation is done by the government in order to back market shock if any should occur. This forex exchange reserved asset could be natural resources that the country is endowed with, which equally serve as their source of revenue. These assets includes; oil, silver, gold, palm oil, electronics and so on. When the economy of the country drops, they rely on their reserved asset to support the country’s economic needs.
Forex exchange reserves also perform the function of liquidity maintenance in case of an economic crisis in the country. Forex exchange reserves play a vital role in the international investment level.
A country’s exchange rate can either be fixed, flexible or mixed exchange rate. When the country’s exchange rate is flexible, the exchange rate is been determined by the market but when the country’s exchange rate is fixed the central bank determines the rate through the implementation of monetary policy. Also, in a country where there is a fixed exchange rate, demand, and supply of the currency may determine its value.
PURPOSES OF FOREX EXCHANGE RESERVES
1. Smaller countries who their economy is not strong enough uses forex exchange reserves to back up their economy. With the help of foreign currency reserve, the country establishes confidence in their own local currency.
2. Forex currency reserve brings about the suitability of a country’s currency value. It does not give room for manipulation of the currency’s value both foreign and local.
3. Forex exchange reserves help a country to establish a stable fixed exchange rate which creates encouraging trade and investment. With this fixed exchange rate, there is no fair of a sudden change of exchange rate.
IMPORTANCE OF FOREX EXCHANGE RESERVES
Forex exchange reserves, as assets or currency held by a country’s central bank can be said to have the following importance;
1. It encourages countries to have confidence in their monetary and their rate of exchange policy since there is no manipulation in the country’s currency.
2. Countries rely on forex exchange reserves assets to support their economy in times of economic recession and financial crisis.
3. It improves the country’s central bank capacity in terms exchange rate stability. The central bank is also in charge of implementation of the exchange rate policy.
4. The participants in the market believe in their domestic currency which is been backed up by forex currency reserves, this enlarges the changes of countries investing in the forex since they know that their investments are secured.
PROBLEMS OF FOREX EXCHANGE RESERVES
1. Diminishing of the reserved assets; the asset which a country reserved mighty have less value before it is been exchanged with the other country
2. The problem of central bank implementing fixed exchange rate policy might actually lead to the diminishing of the currency value when there are low demand and low supply of the asset or currency.
3. Another problem of forex exchange reserves is that some countries that have reserve may be running flexible exchange rate policy and in this case, the policy rate is determine by the market and not the central bank of the country thereby making reserves not being necessary. In this situation, the market makes use of the interest rate in their monetary policy.
4. They might be currency crisis or devaluation and this may be as a result of no-sterilization in the domestic currency in circulation.
5. There is also the problem of differences in the interest rate of the domestic currency and foreign exchange reserve. At the period of exchange, the domestic currency earn might be less compared to that of foreign.
SOLUTION TO PROBLEMS OF FOREX EXCHANGE RESERVE
1. They should be an establishment of international facilities and they should be provision for revenues for some domestic spending and some other social activities.
2. Resources should be pool out via an agreement with the foreign exchange.
3. They should be sterilization in the domestic currency circulation.
Forex exchange reserves as the currency or asset held or reserved by the central bank are actually very vital for countries most especially at the point of their economic recession. Reserved currency can be in fixed, flexible and in mixed form. It also encourages liquidity which provides financial safety.