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.
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.
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.
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
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
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…