Why do you need foreign currency reserve?
India is a large importer of crude oil and since trades are settled in dollars, the country needs adequate US dollar reserves to pay for crude oil and other imports. India imports more than it exports and hence must ensure decent forex reserves, which it at the moment it has.
In 1991, India had a small sum of $1.3 billion in foreign exchange reserves, enough to pay only for three months imports. India then airlifted gold and took an emergency loan from the IMF of $ 2.2 billion. The country under former PM and former FM, Manmohan Singh came out of the economic mess and managed to build forex reserves.
This in itself explains the dire need for having enough foreign exchange reserves. One needs foreign currency to settle trades.
Also, if the Indian rupee depreciates rapidly due to demand for dollars, the RBI can sell dollars and support the rupee. Holding large amount of foreign currency reserve is a mark of strength for any economy. Generally, it is held in US dollars, US Bonds, US Treasury Bills, gold etc.
What is this world's currency reserve?
Let's begin by understanding: what is this world currency reserve? According to Investopedia, in 1944, delegates from 44 Allied countries met in Bretton Wood, New Hampshire, to come up with a system to manage foreign exchange that would not put any country at a disadvantage.
It was decided that the world's currencies couldn't be linked to gold, but they could be linked to the U.S. dollar, which was linked to gold. It was decided that the central banks of each country would maintain fixed exchange rates between their currencies and the dollar.
According to Investopedia, due to this Bretton Wood Agreement, the US dollar became the world's reserve currency, and investors started piling-up US dollars.
The question arose of how to save US dollars? So, countries began investing in US Treasury Securities or in simple terms US Government securities. Today, most of the forex reserves of many countries are in US dollars (cash), US government securities and US Bonds.
Will the US dollar lose its status as the world currency reserve?
It's interesting to note that the US dollar share of foreign reserves fell from a high of 73 per cent in 2001 to 62 per cent at the end of 2018.
While the US dollar may not lose its status as the world's reserve currency anytime soon, its dependence could certainly reduce. For example, restrictive policies of the US could move countries like Russia and Iran away from the US dollar. It's highly possible that given the US-China trade tensions, the latter might also chose to reduce dependency on the US Dollar. This could certainly hurt, given the sheer dominance of China in world trade.
If policy problems with the US cannot be settled, countries may find an alternative route for trade settlements in place of the US dollar. According to a CNBC report France, Germany and the U.K. set up the Instrument in Support of Trade Exchanges (INSTEX) last year to work around U.S. sanctions on Iran. It may not be long before the Euro too starts playing a significant and perhaps a dominant role in currency trade and hence currency reserves.
Apart from this, it is highly possible that countries would like to also keep reserves in gold. The precious metal has hit record levels and record inflows into gold etfs are a reality today.
The dominance of the US in trade, the economic size and the spending power (despite trillions of dollars in debt) has kept the US dollar as the world's currency reserve. However, nothing can be taken for granted and things can change and change swiftly.