UGC NET COMMERCE December 2018 Q60
- Option : D
- Explanation : International Liquidity and International Reserves
International liquidity refers to those financial resources and facilities that are available to a country for financing the deficit in its balance of payments. The various components of international liquidity are gold and foreign currencies held by the monetary authority of a country, borrowing facilities available from the IMF, special drawing rights (SDRs), the borrowing capacity of the country in the international market, and so on. Thus, the term “international liquidity” refers to the country’s international reserves as well as its capacity to borrow in the international market. Where gold is held as a reserve asset, its market value is listed, but gold cannot be directly used to settle payments between central banks. In other words, gold is no longer used as a means to settle international payments. Official reserve holdings may include some foreign currency that is universally acceptable and convertible. Throughout the latter part of the nineteenth century, the British pound served as a universally acceptable currency alongside gold, into which it was convertible. Subsequently, the U.S. dollar has rivalled the GBP as a world currency. Any currency which is to serve satisfactorily as a reserve currency for other countries should satisfy certain conditions. It must be the currency of a great trading nation. The currency should be easily acquired via normal trade. It must have a stable value, or at least, in a world where currencies are losing value, it must lose value no faster than other currencies. It must be a currency that is supported in its home country by a strong banking system. Such a currency must also be free from recurrent scarcity. Any currency which is a candidate for the international reserve must be close to meeting these criteria, and the extent to which it conforms to them is likely to determine its success.
The main purposes of holding foreign exchange reserves are: (i) to maintain public confidence in the capacity of the country to honour its international obligations; and (ii) to increase the capacity of the monetary authority to intervene in the foreign exchange market. In other words, foreign exchange reserves are mainly held for precautionary and transaction motives, and also for achieving a balance between demand and supply of foreign currencies.
