Forex Reserves Management

Forex Reserve

What is Forex? Definition of International Monetary Fund (Balance of

Payments Manual, and Guidelines on Foreign Exchange Reserve Management, 2001).

Reserve Bank of India Act 1934 - enabling provisions for the RBI to act as the custodian of foreign reserves, and manage reserves with defined objectives.

The foreign exchange reserves include three items; gold, SDR and foreign currency assets. (SDR- a transferable right to acquire another country's currency)

Definition of Forex

Foreign currency and the securities held by the public including the banks and corporate bodies are not accounted for in the definition.

RBI manages reserve in an extremely conservative fashion within the overall policy framework agreed upon with Government of India.

RBI functions as the custodian and manager of forex reserves.

Importance

Primarily as a last resort stock of foreign currency for unpredictable flows.

Related to wealth and the cost of covering unplanned deficit.

Maintain or manage the exchange rate, while enabling orderly absorption of international money and capital flows.

The aggregate of national interests, to achieve balance between demand for and supply of foreign currencies, for intervention.

Preserve confidence in the country’s ability to carry out external transactions.

Importance

So a list of objectives in broader terms may be encapsulated –

Maintaining confidence in monetary and exchange rate policies

Enhancing capacity to intervene in forex markets. Limiting external vulnerability by maintaining foreign

currency liquidity to absorb shocks during times of crisis including national disasters or emergencies.

Providing confidence to the markets especially credit rating agencies that external obligations can always be met.

Providing domestic macroeconomic stability and economic growth.

Evolution of Reserve Management Policy in India BOP Crisis 1991- Increased borrowing from foreign sources in the late

1980s, which helped fuel economic growth. August 1990 -Iraq invaded Kuwait, and the price of oil

soon doubled. Domestic social and political instability - government

fell in November 1990 and was succeeded by a minority government.

Paradigm shift with the loosening government regulations, especially in the area of foreign trade.

Current status and policies INDIA is said to be a 912 billion dollar economy with

growth of close to nine per cent for over three years. reserves has steadily increased from US$ 5.8 billion

as of 1991 to US$ 300.5 billion as at August 8,2008.

Inflow: Currently holdings of gold have been virtually

unchanged other than occasional sales of gold by the government to the RBI. The gold reserves are managed passively.

Foreign currency reserve is mainly purchased by RBI from the Authorized Dealers (Open market Operation)

Deployment of forex assets held in the portfolio of RBI (i.e. reserves) which are invested in appropriate instruments of select currencies as per the RBI act.

Current status and policies

Outflow: Sale of foreign currency to Authorized Dealers Forex is made available from reserves for

identified users to meet the demands of forex market.

Sometimes reserves are used as a convenient mechanism for government purchases of goods and services, servicing foreign currency debt of government, insurance against emergencies, and in respect of a few, as a source of income

FX Reserves Management – A Critical Appreciation

Deployment in US Government papers – ensuring safety and liquidity but low yields

Holding sufficient reserves protects a country from external shocks(capital flight and currency crises) but opportunity costs are involved (opportunity cost of not using these

resources to help increase domestic productivity.) Rangarajan Committee Report – Fixing FX reserves

target for 3 months import

FX Utilization-New Strategies

Create Sovereign Wealth Fund like Temasek, GIC(Singpapore), KIA (Kuwait)

(for investing in corporate sovereign bonds, equities, real estate holdings and

private equity holdings in different parts of the world) Investment in domestic infrastructure Acquire new technologies to scale up productivity of

the industry help corporate entities to aggressively restructure their

expensive foreign debt or allow the government to use them for repaying the high cost of debts that are outstanding

Conclusion

GoI and RBI should promote studies and research to Examine the possibilities for identifying more

“development-friendly” determinants of the size and structure of foreign reserves

Assess the “optimality” of the foreign reserve policies in economies of the region

Support the exploration of alternative approaches to the management of reserves portfolios

Explore the possibility of creating collateral credit facilities in the region International organizations, such as IMF, World Bank, Asian Development Bank etc…