“managing India’s Foreign Exchange Reserves”

“MANAGING INDIA’S FOREIGN EXCHANGE RESERVES”

 

Foreign Exchange Reserves (FER) is the surplus money or capital that a country parks or maintains in the foreign country in form of currency, bond and other kind of securities.

 

Foreign exchange reserves are the foreign currency deposits held by national banks of different nations. These are assets of Governments which are held in different hard currencies such as Dollar, Sterling, Euro, Yen, Gold, SDRs. The current FER of India amounts to $251.33 billion as on 14 Oct as declared by the RBI. This amount seems an alien like figure when we look back to the early 90’s when we had just enough reserves to meet our country’s demand for the next two weeks. The total forex reserves have risen from $3.96 billion in March 1990 to $251.33 billion as on 14 Oct 2007.

 

Movements in Foreign Exchange Reserves (at the end of March)

 

 

 

 

OBJECTIVE:

 

The objectives of my article are as listed below:

 

1.      To study and analyze the current methods RBI uses to manage our FER.

 

2.       Analyze how other countries like China, Abu Dabhai and Singapore with large FER manage their reserves and whether India can also opt for these processes to obtain higher ROI.

 

3.      I would like to list out various other innovative and new options and avenues towards which India can look to which will benefit the country and its people, for getting higher returns on its reserves while minimizing the risk involved; as the primary objective of having a reserve is to provide a cushion in case of any emergency or financial crisis. I would also like to forward these suggestions to the RBI.

 

LITERATURE SURVEY:

 

1. “Determining the Optimum Level of Foreign Exchange Reserves”,

 

By Sajikumar, Treasury Management. The Icfai University Press, November, 2005.

 

The author says that the increase in the inflows of the foreign reserves in the country by the route of ADRs, GDRs, FDIs, ECBs, portfolio investments, non-resident deposits and bank capital raises the question of an ‘optimum’ level of reserves. Further, he discusses about the reserve adequacy indicators: Trade related indicators (reserves should be equivalent to a few months of imports), Debt related indicators (reserves can meet the external repayment obligations without additional borrowing for one year- Guidotti rule) and money-related indicators i.e. reserves to broad money/ reserves to reserve money.

 

2. “Should India Use Foreign Exchange Reserves For Financing Infrastructure?”

 

By Charan Singh, Stanford Center for International Development, September 2005

 

The author states the primary objectives of maintaining forex reserves is safety and liquidity, maximizing returns is secondary. The forex reserves in India are managed by RBI in consultation with the Government of India. The opinion of the author is that India should not invest forex reserves in Infrastructure. Going ahead he says, infrastructure projects in India yield low or negative returns due to difficulties: political and economic — especially in adjusting the tariff structure, introducing labor reforms, and upgrading technology and the use of FER to finance infrastructure may lead to more economic difficulties, including problems in monetary management.

 

3.“Surging Forex Reserves: A Frankenstein’s Monster?”

 

By GRK Murti, Forex Markets, Current Trends, The Icfai University Press, November, 2005.

 

The author talks about the surging forex reserves of the country and states that the level of forex has surpassed the adequate level. The author further says that the hoarding of forex reserves in the overseas markets has made it a Frankenstein’s Monster. Hoarding means savings that is put aside for the future use and this also entails an opportunity cost to it. He also opines that the RBI should take the risk of deploying these reserves in infrastructure projects or retiring high cost existing debt.

 

4.“India’s Forex Reserves Deployment Dilemma”

 

By Priyanka Sugandhi, Forex Markets , Current Trends. The Icfai University Press, November, 2005.

 

The author has shown the dilemma being faced by the RBI in deploying its forex reserves by citing the costs and the benefits associated with the huge forex reserves. The benefits being the foreign currency liquidity enabling the economy to absorb shocks like during the oil crisis, and high forex reserves also depicts the ability of the economy to meet its external obligations. The costs associated being the opportunity cost of deploying the reserves into the developed countries which gives low returns as compared to what Indian Government pay to its domestic borrowings whereas the bond market in developed countries are very liquid and do entail very low credit risk.

 

ISSUE:

The unprecedented rise in Foreign Exchange Reserves (FER) in India has raised concern about its optimal size and appropriate utilization. The amount of FER in India is modest when compared to some of the other countries in the region, and it can be argued that the proposed plan may lead to more economic difficulties than anticipated benefits. Safety and liquidity are paramount in the management of reserves and these demand that reserves are held mostly in G-7 central banks or Treasury bills of the highest quality and the lowest yields. The usual favorite in the latter are those issued by the US Government. Bonds are no better. Investments in G-7 bonds too are characterized by low yields, given the low level of global interest rates. Every country needs a minimum level of reserves for imports, debt-servicing and market intervention to ward off possible speculative attacks on the currency.

 

 India followed a restrictive external sector policy until 1991, mainly designed to conserve limited FER for essential imports (petroleum goods and food grains), restrict capital mobility, and discourage entry of multinationals. The external sector strategy since 1991, though gradualist in approach, has shifted from import substitution to export promotion, with sufficiency of FER as an important element. As a result of measures initiated to liberalize capital inflows, India’s FER (mainly foreign currency assets) have increased from US$6 billion at end-March 1991 to US$251 billion at Oct 2007. The acceleration in the trend first emerged in 1993, as recorded by the rise in foreign currency assets, when India adopted the market-based system of exchange rates and then in 2001, when the current account recorded a surplus after a persistent deficit since 1978. India ranks sixth in the world in holdings of FER in 2007.

 

The recent surge in FER has occurred primarily because of an increase in:

 

1.      Work Remittance

 

2.      Exports

 

3.      Capital Inflow

 

The RBI being the custodian of the FER has to decide how to manage the FER. This job is by no means an easy task and the controversy that surrounds the usage of our FER still looms at large. Some skeptics say that FER are a cushion for the country in case of an economic crisis and help in bailing out the country in case of an emergency. However it wouldn’t be wise to let our FER just keep on piling up and not utilize them judiciously. We can utilize our FER to improve our infrastructure, which is very desperately needed to sustain the rapid growth we are witnessing in our country at this moment, we can also utilize our foreign reserves to repay our short term high interest term loans taken from foreign financial institutions, using reserves to acquire foreign assets including technology or we can also utilize our reserves for social welfare to eradicate poverty. The ways in which we can utilize our resources are endless but we must take care not to overdo it. However not utilizing our reserves has an opportunity cost attached to it as the RBI primarily invests and parks its reserves in low yielding US govt. bonds.

REFERENCES

1.   Cardon Pierre And Joachim Coche, “Strategic Asset Allocation For Foreign Exchange Reserves”, Risk Management For Central Bank Foreign Reserves, European Central Bank, May 2004.

      2. Dwyer Mark and John Nugée, “Risk Systems in Central Bank Reserves Management”

, Risk Management for Central Bank Foreign Reserves, European Central Bank, May 2004.

 

3.      Damodaran Harish, “The `Other Capital’ Factor In Forex Reserves Accretion”, Financial Daily. The Hindu Group of Publications, Wednesday, Jul 02, 2003.

 

4.      Patnaik Ila And Peter Pauly, “The Indian Foreign Exchange Market And The Equilibrium Real Exchange Rate Of The Rupee”, Ncaer, Delhi And University Of Toronto, February 2001.

 

5.      Sajikumar, “Determining the Optimum Level of Foreign Exchange” Reserves, Treasury Management. The Icfai University Press, November, 2005.       

 

6.      Singh Charan, “Should India Use Foreign Exchange Reserves For Financing Infrastructure?” Stanford Center for International Development, September 2005

 

7.      Sugandhi Priyanka, “India’s Forex Reserves Deployment Dilemma”, Forex Markets,Current Trends. The Icfai University Press, November, 2005.

 

8.       Murti GRK, “Surging Forex Reserves: A Frankenstein’s Monster?”, Forex Markets, Current Trends, The Icfai University Press, November, 2005.

 

About the Author

Amit Singh Bisht

B.E., MBA (pursuing from IBS HYderabad)
09705858331
bishtsinghamit@gmail.com

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