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India's foreign exchange reserves have just scaled the $100 billion mark---yippee! Is it time for a relook at the pile-em-up strategy?
India has hit the three-digit mark. The country now has $100 billion in foreign exchange reserves. 'Foreign exchange' means US dollars, of course --- and that's also the reason that voices pipe up every now and then, wondering if it wouldn't be better to have at least some of it in euros. The dollar has been sliding against the euro... and the trend doesn't seem like reversing itself anytime soon. Money held as euros is thus gaining in value, and relative to money held as dollars, sharply so. Shouldn't India's reserves be managed as any treasury would at a value-maximizing bank? Wouldn't euro bonds deliver better returns than US Treasury Bills? It's good that such questions are being asked. But, as any treasury professional will tell you, it's not as simple as arriving at some dollar-euro ratio. The formulation of an effective reserve management strategy involves varied variables --- some of them too complex for casual observers, as many euro-drumbeaters are, to understand. Yes, it is time that the reserve strategy be a matter of public debate... and with special emphasis on the word 'strategy'. Just stuffing the vaults in fear of long-exorcized ghosts from 1991 is plainly irrational (and it seems unlikely that India would need reserves to shore up the rupee). Disaster-protection was once a worthwhile objective, but by the look of things, no longer so. But no, that doesn't mean India does the obvious thing - trade some dollars for euros, and feel pleased with itself for 'diversifying' its reserves. Other countries haven't been doing it, and it would pay to understand why. Make no mistake: the US remains the world's center of financial gravity. Also, the published value of the euro in itself is not the key decision point. A lot depends on the state of the market for euro-denominated assets, particularly sovereign debt. While financial experts admit that European futures markets are fairly efficient (thanks partly to modern technology), the liquidity of the euro-bonds market --- relative to the T-bills market --- is still under watch. Trading has indeed been picking up, as would be expected now that the euro is a success in most analysts' reckoning. But it's still not clear if the market can happily absorb large central-bank size transactions without wobbling under their own force. Those are the external factors. Internally, India's strategy would depend on the nature of the international payments it must make. In the old days, oil was the chief import (despite import liberalization, this is still much the case), and oil was paid for in dollars. It still is, and it's nigh impossible to find a significant oil exporter accepting euros. The new world order is still a greenback world order. Most of India's other trade is also dollar-denominated, particularly services. In fact, a big reason India is earning so many dollars is the IT export thrust to the US market. Also, most surplus-cash NRIs are US-based, and they have discovered the wonders of holding non-resident dollar accounts in India (which give higher interest than equivalent options in the US... one can even borrow dollars at 3 per cent and get 5 per cent in India). Business transactions, though, are the ones that count. While some IT firms have expressed intentions to diversify their client base 'across geographies' as a hedge against the sliding dollar, there is little to suggest that the current state of currency dealings will undergo any radical transformation. Most of the currency that Indian businesses need would also be dollars. If the Indian rupee were made freely convertible on the capital account (plans for which might be re-initiated now that the reserves are so high, even if the fiscal deficit is still way too high), most analysts expect the demand to be mostly for conversion to dollars. So that's a 'market' preference indicator of sorts. Besides, China is the country to watch. Its dollar reserves are about four times India's, and nobody has accused it of being lazy or confused about matters of national interest. If China starts diversifying its reserves, it would be important to understand why. On the whole, the idea is to be strategic about it. Even if the pile-em-up policy continues, we should have a darned good reason why.
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