RBI may be internally exploring shedding its traditional approach to foreign exchange reserve management amidst falling global yields adding to the fiscal costs of managing the reserves. A research paper by RBI economists suggests that the central bank should be more active in its forex assets management including looking beyond SDR currencies and active management of its gold reserves.
Global interest rates which have been on declining over the last four decades in advanced economies, touched their historic lows in 2020. “This low yield environment has made it an arduous task for the reserve managers to generate reasonable returns on their foreign assets” said a paper by Ashish Saurabh and Nitin Madan of RBI’s department of External Investments and Operations.
” Reserve managers can deal with the low yield environment by increasing the duration of their portfolios, investing in new asset classes, new markets and more active management of their gold stocks” they said adding that the choice of strategy, however, would require to be tailored to suit the risk appetite, investment priorities, skill sets and operational capabilities of individual institutions.
In its latest annual report, the central bank said that its agenda for 2021-22 was to “Continue to explore new asset classes, new jurisdictions/ markets for deployment of foreign currency assets (FCA) for portfolio diversification and in the process tap advice from external experts, if required”
RBI is fast accumulating dollars during the pandemic which is $639 billion dollars as of October 08 and more than $100 billion piled up since the pandemic, which adds to the challenge of foreign exchange reserves management.
Low returns on reserve deployment impacts RBI’s income . The surplus or profits that RBI makes in year is transferred to the government, which in to helps it to manage fiscal deficit. But at the same time the foreign investor from whom RBI buys the dollar ends up earning much more from the local investments. Also, a pile of reserves adds to the liquidity management challenge for the central bank. Income from foreign sources dipped 47 per cent in FY’20-21 to Rs 25, 469 crore, despite a strong pile-up in reserves. The central bank managed higher surplus transfer to the government on account of lower provisioning during the year, though it was a truncated accounting year for the central bank.
According to a survey by central banking portal ” Centralbanking.com”, reserve managers have found the reduction in yields since March 2020 as the most challenging aspect of their work. Most of the participants in this survey conducted in February-March’21 accepted that the low yield environment, notably in major reserve currencies, has changed the reserve management policies and practices in favour of investments in new markets, investments in new asset classes, investment in more currencies and changes in minimum credit rating accepted.