India Forex Reserves-Abysmal Returns-VRK100-13Mar14

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(Please check two important updates 10Nov2023 and 08Mar2022 on India's Forex Reserves)

 

 

 

Abysmal Rate of Return on India’s Forex Reserves:

India’s foreign exchange reserves do not earn much returns for the Reserve Bank of India, that is, for the Government of India. They are abysmally low. During the period July 2007 to June 2008, the returns were 4.82 percent. But since then earnings rate of our foreign exchange reserves has come down drastically.

As per the latest data from Reserve Bank of India, the earnings rate on India’s foreign currency assets and gold has come down to a meager 1.45 percent for the period starting from July 2012 to June 2013.  It may be noted that lower rate of earnings reflects generally low global interest rate scenario, that has been prevalent across most of the developed markets since the 2007-2008 global financial crisis.

Accretion to foreign exchange reserves is highly expensive. When RBI buys foreign exchange (mostly US dollars) to add to its reserves, it releases money (rupees) into the banking system. To neutralize the impact of excess money, RBI issues government securities and takes away that money from the banking system. This process is called sterilization, which entails huge cost to the Government. 

RBI resorted to massive accretion of foreign exchange reserves in 2006 and 2007 to arrest steep appreciation of rupee’s external value against the US dollar. The excess money created in the banking system was simultaneously absorbed through normal open market operations (OMOs) and Market Stabilisation Scheme (MSS).

RBI deploys these foreign exchange reserves in several instruments, mainly in the US Treasury securities and earns some return on them. Of course, there are various objectives of holding these reserves. Earnings are just incidental to the larger objectives of macroeconomic policies. 

India’s Import Cover is Declining:

India’s import cover is on the decline for the past six years. From a recent peak of 12.4 months at the end of September 2009, it has nosedived to 6.6 months for September 2013, as per the latest data from RBI.

Indian rupee witnessed steep depreciation against the dollar in the past few years, due to a variety of local and global factors. RBI intervened heavily in the markets and sold foreign exchange to shore up the rupee’s external value, resulting in erosion of reserves. (Of course, reserves are now increasing and the latest figure is $ 294.36 billion. Rupee is now gaining against the US dollar in the past few months).

India’s import cover fell to a low of three weeks of imports as at end of December 1990; reached a peak of 16.9 months of imports as at end of March2004. Import cover is the number of months of imports foreign exchange reserves could pay for.

Related Articles:

Spectacular Rise of Rupee Amidst Weak Leadership

Indian Rupee Continues to Fall

Date source: RBI website. Note: RBI’s financial year starts from July and ends with June.

Disclaimer: The author is an investment analyst. He blogs at:

http://ramakrishnavadlamudi.blogspot.in/   http://www.scribd.com/vrk100  Twitter @vrk100