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Definition: Foreign Reserves
Foreign reserves are generally the assets which in the form of the prevailing reserve currency (mostly US dollars) are possessed by the central bank of a country and predominantly used to back its liabilities. It is mostly in the form of the reserve currency or bonds or gold.
They are very useful when the currency of the home country is weak in times of financial crisis and also help the government to follow mixed exchange-rate policy. It is closely related to the monetary policy.
E.g.: Today (December 15th, 2013) the Reserve Bank of India announced that the foreign reserves of India has risen up to $295.7 bn. The statement indicates that the central bank of India which is the RBI has assets of $ 295.7 bn. This reserve surplus may be due to the inflow of dollars from FDI or FII which is foreign direct investors or foreign institutional investors.
These FDI or FII invest in India in dollars since it is the standard currency which adds to the reserve of RBI in exchange of the local currency: Indian rupees. This in turn indicates a healthy economic condition in India orienting towards growth and lower exchange rate of rupees with respect to dollars.