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RBI pulls out forex from foreign banks
May, 31st 2008

The central bank appears to have carried out changes to its forex reserve management strategy by pulling out substantial funds parked with many high-street banks. The shift may have been prompted by the recent developments in the global financial markets.

New data available with the Reserve Bank of India pertaining to the period between March 2007 and March 2008 shows that although forex reserves rose by more than 50% during this period, the deposits parked by the central bank with foreign banks around the world dipped from $46.7 billion in March 2007 to $6 billion in March 2008.

These funds are now being placed with other central banks and mutlilateral agencies where the returns are reckoned to be relatively low. Indias foreign exchange reserves aggregated $309 billion at the end of March 2008. It has swelled to $313 billion in April-end, making India the sixth-largest custodian of forex reserves in the world.

This dip has been particularly steep since July 2007, which coincides with the turmoil in credit markets in the West. This was the period during which the US subprime crisis snowballed, impacting the global financial markets.

 Top-rated global banking majors have taken a major hit during the past few quarters on account of their investment in mortgage securities. This may also have influenced the RBIs decision to change gears in the near term and berth in safer shores. The move may have an impact on the RBIs income from overseas investments.

Over the past few years, income from foreign sources have accounted for more than 75% of the central banks total income. But, RBI has always maintained that its primary aim when it comes to foreign exchange reserves management was to ensure safety and liquidity, with higher returns figuring lower in the hierarchy of preferences on this issue.

RBIs parking of reserves is consistent with the best practices laid down for central banks by the International Monetary Fund (IMF). This includes parking part of the reserves as cash deposits with foreign central banks and multilateral agencies such as IMF and the Bank for International Settlements (BIS).

It also invests in the deposits of foreign commercial banks and bonds, generally the highest-rated sovereign bonds of leading economies and occasionally in top rated corporate bonds. Indias foreign exchange reserves are spread across a variety of currencies including the dollar, euro and yen.

But, the precise currency composition of reserves is generally not released by most countries including India, going by global practice. According to RBI, this is because short-term variations in reserves held in different currencies by central banks are regarded as being market sensitive.

 The central bank had, as part of a conscious strategy, started parking a higher portion of its reserves with foreign commercial banks, allowing them to manage them in the past five years. According to the Reserve Bank of India, "A small portion of the reserves is assigned to external asset managers with the objectives of gaining access to and deriving benefit from their market research. This also helps to take advantage of the technology available with asset managers and to provide training/exposure to the Reserve Banks own dealers."

Funds parked in bonds (which typically have a longer-term perspective against cash deposits, which normally do not exceed a years tenure) have been steady.

A major portion of the securities are custodised with central banks, mainly the US Federal Reserve, the Bank of England and the Bank of Japan. However, following the new shift, RBI may end up incurring a higher cost for holding the reserves

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