Since 1994, foreign currency reserves have been increasing in India. With reserves of more than $60 bn today, India already has the capacity to cover nearly one year of import requirements. A high level of reserves is what the Central Bank of any country looks for at any time, as high level of reserves not only proclaim a country's financial strength but also help in meeting its financial obligations. However, such huge reserves have opportunity cost and therefore it is necessary to put forward some policy to redefine the concept of reserve adequacy, as it might so happen that India might be losing valuable investment opportunities by holding excessive reserves.

Currently, growing foreign exchange reserves in India have been the matter of discussion among policy makers and economists. The present level of foreign exchange reserves is sufficient to cover nearly about one year of import requirements. Keeping such a high reserves has an opportunity cost in the form of interest payments and also it has unfavorable effects on domestic economy. In this context, it is appropriate to have a policy on "Optimum Foreign Exchange Reserves". Although, there is no specific guideline yet, alternative criteria have been put forward to measure the optimum foreign exchange reserves.

Before assessing the optimum foreign exchange reserves, it is essential to know the need for keeping foreign exchange reserves. The practice of keeping foreign exchange as a reserve has been undergoing policy shift over the years. During Bretton Woods' era of exchange rate regime, countries were keeping foreign exchange mainly for imports requirements. This policy has changed with the adoption of market determined exchange rate regime. Now the prime objectives of maintaining reserves are "confidence building" and maintaining stability in the exchange rate market, besides import requirements. the element of subjectivity, coupled with market is difficult to quantify the optimum foreign exchange level. Optimum foreign exchange reserve is country specific and it depends upon its position in the international financial market and also the confidence it commands from the investors.

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