The term “foreign exchange reserves” refers to the supply of foreign currency currently being kept by the central bank of a specific country’s central bank. Alternatively known as forex reserves or FX reserves, this is comprised of a variety of international currencies. Of course, it is quite natural for the strongest currencies to be prioritized in this roster. As such, the US dollar is one of the most common currencies available in the reserves of most countries.
One of the main functions of the regulation of foreign reserves is the maintenance of a specific currency’s stability. It is therefore in the best interest of the country for its central bank to ensure that the amount of reserves kept is in keeping with a sound monetary policy. These policies are, of course, dependent on the financial direction and strategy the central bank has decided to adopt. They can also bring about other actions which may influence the balance between the local currency and that of foreign currencies. For example, more local currency can be produced. Such an act may be appropriate in certain cases, but this likewise has to be regulated in order to avoid excessive inflation.
Holding large foreign exchange reserves is generally desirable and beneficial because this gives the country more power to ensure the stability of its economy. Aside from simply bringing about a more positive impression of the financial health of the nation, this also serves as a good defense mechanism against speculation. On the other hand, this also poses a certain level of risk for the country in question, since huge reserves can also translate into huge losses in the event of undesirable changes in the foreign exchange market.