Explanation:

The Foreign exchange reserves of India consists of below four categories: Foreign Currency Assets, Gold bullion, Special Drawing Rights (SDRs), Reserve Tranche Position in the IMF. As of September 2017, India's foreign exchange reserves are mainly composed of US dollar in the forms of US government bonds and institutional bonds with nearly 5% of forex reserves in gold. India is, coincidentally the world's largest gold consuming nation mainly due to the cultural importance attached to Gold and the large population. The reserves are managed by the Reserve Bank of India and the main component is foreign currency assets.

Foreign exchange reserves act as the first line of defense for India in case of BoP crisis. While forex reserves act as insurance when the rupee tends to be volatile against the dollar, there are costs attached to it. When RBI purchases dollars in the spot, it leads to infusion of rupee into the system which leaves inflationary effect on the economy. Since the RBI does not want such actions to create inflationary pressure, so, it converts spot purchases into forwards. 'This way, it is a direct cost because of the forward premiums. If RBI opts for open market operations (OMOs) to mop up excess liquidity, that also involves costs. Also, the idle forex can be used to finance infrastructure and other developmental projects and reduce their cost of upkeep.