ONE of the features of recent Budget speeches, including the latest one of Mr Jaswant Singh, has been an expression of satisfaction at the level of reserves.
Mr Jaswant Singh, in particular, mentioned that the current level of reserves "liberates us from the mentality of want" — a relaxation of the forex constraints that characterised the entire history of India up to now.
The Finance Minister had referred, in particular, to the "first-ever" report of the RBI on foreign exchange reserves, released to be (fortuitously?) timed with the presentation of the Budget.
The RBI had, of course, come out with a similar, but not so comprehensive, exercise explaining the growth of forex reserves sometime back in 2003.
Anyway, exultation seems to be in order, considering the forex reserves above $100 billion.
The RBI report, however, does not content itself with merely detailing the origins of reserves.
It notes that the IMF has included India in a list of countries that have credible forex reserve management practices and seeks comfort in the IMF's plaudits for the RBI's management. Such plaudits are, indeed, richly deserved.
The RBI report is based on information up to September 2003. It is, indeed, debatable whether in these days of "real time" settlement across the world the report could have been more useful had it been more current — brought up-to-date as of December 31, 2003 or January 31, 2004, if possible.
Considering the increased technological sophistication of the RBI's management information systems, such updating of the report should not be beyond its capability.
The report is, however, on conventional lines. While it gives information as to the origin of the growth in reserves starting from the crisis year 1991 until the recent past, it also provides some information on the methods adopted to ensure that the reserves are invested in safe and liquid assets.
The fact that the reserves have had a low return of around 2 per cent in 2003 is reflective of the global low interest regime.
The causes of the rise in reserves from crisis year 1991 to September 2003 are broadly brought out in Table 1.
We observe from the Table that most of the sheen in forex reserves has come from borrowed feathers. The overall "improvement" in current account has been negative. That is to say, during the period since reform, total imports of goods and services have exceeded exports by $31 billion.
There is a slight "improvement", however, in the profile of different elements in the BoP to forex reserve growth in the recent period April-September 2003, as shown in Table 2. Foreign direct investment alone in this period amounted to $4.7 billion. The current account had shown a small surplus in this period.
The RBI's report also incorporates an interesting table (Table 3) on what it calls India's "international investment position". There is clearly an excess of liabilities over assets on the forex front.
This should raise alarm signals. One caveat is, however, in order. The figure of $91 billion mentioned in the Table under the head "Other investments" does not seem to be fully supported by data.
I hope their status and details are fully known only to the RBI. Greater transparency on the composition of the head of "Other investments" would have helped to give credibility to the RBI's measure of India's international net investment position.
The currency composition of India's reserves investments has drawn attention recently because currency risk is attributed to certain currencies, like the dollar. The RBI's report, however, discloses little new information on the currency composition.
The IMF's related document, which the RBI report cites as describing currency reserve management practices among various countries, also reveals little of significance.
Some requirements mentioned in the IMF report note that in the case of Hong Kong (SFR), a specific percentage of its assets should be deployed in dollar assets and another specific percentage in Euro.
But there are also instances of countries, which seek refuge under cover of the statutory need for security and do not disclose the precise currency composition of their reserves. It is perhaps symptomatic of central banks that they tend to be secretive about how they invest their reserves.
The RBI report, however, gives some information on the broad distribution of investments as shown in Table 4.
The report adds that the RBI's practices ensure that securities in which it invested have the highest credit ratings and are above all eminently liquid. Deposits with foreign commercial banks account for $15.83 billion. Some of these, however, flow back to India as external commercial borrowings by Indian corporates.
The RBI might well keep a part of its reserves as deposits with select Indian banks for being on-lent to Indian entities in place of external commercial borrowing, but at reasonable spreads of rates of interest. This will be definitely more remunerative than the current practice.
Overall, the RBI's latest report on forex reserves is a treasure-house of information, although it takes some of the joy out of our gloating over the $100 billion of reserves.
It raises alarm signals about the need to depend less on foreign borrowals and portfolio investment and more on current account surpluses. Not that Government of India/RBI are not aware of these caveats. But it suits them to dwell less prominently on what contributes to the $100 billion that India has today. The RBI's report shows that we have to tread warily in spite of the abundance of forex riches.
In this context, the RBI report addresses specifically the frequently asked question as to what level of reserves can be considered adequate.
The RBI report discusses at length the question of the adequacy of reserves. The latest theory and practice both are cited in support of maintaining the current high level of reserves.
Portfolio investment is especially volatile. The Rangarajan Committee on Balance of Payments had suggested that in addition to the traditional measure of import cover of up to three to four months, attention should be paid to repayment obligations.
The Tarapore Committee on Capital Account Convertibility had also suggested alternative measures of adequacy, which in addition to trade-based indicators also included money-based and debt-based indicators. In the recent period, assessment of reserve adequacy has been influenced by the addition of more sophisticated measures relevant to emerging market economies like India.
One such measure requires that the usable forex reserves should exceed scheduled amortisation of foreign exchange debts assuming no rollover the following year.
The other measure is based on a "liquidity at risk" rule that takes into account risks that a country could foresee.
This implies that a country's forex reserves liquidity position should be calculated under a range of possible outcomes for various relevant financial variables, such as exchange rates, commodity prices (such as oil), credit spreads, etc.
The RBI has done various exercises "based on intuition and risk models" in order to estimate such liquidity at risk of the level of reserves. Hopefully, the RBI is auditing its models with expert advice from experienced analysts and institutions.
Overall, the level of reserves is such as to dispel suspicions of vulnerability. The import cover of reserves, which fell to a low of three weeks of imports, has risen to around 14 months of cover now. It has also about five years of debt servicing as at the end of March 2003.
At the end of September 2003, the import cover was five-six months. It is significantly higher now. More importantly, the ratio of short-term debt to foreign exchange reserves declined from 46.5 per cent at the end of March 1991 to 6.1 per cent at the end of March 2003.
The ratio of volatile flows defined as cumulative portfolio flows and short-term debt has also declined to 36 per cent as at the end of March 2003 from 146 per cent in end March 1991. All in all, an adequate level of reserves, in spite of the reservations disclosed in the RBI's latest report!
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