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Deploying reserves imaginatively

The resilience of the Indian economy, especially its external sector, is often illustrated by the growing forex reserves. Thanks to surging foreign currency inflows of all types, the aggregate reserves, currently at over $203 billion, surpass India's external debt, which is in the region of $142 billion. With a large proportion representing non-debt creating inflows, the reserves are stable and will be available to fend off any financial crisis. However, while the rationale of building up such huge reserves is easily understood, there have been conflicting opinions on their optimal deployment. At present, most Asian central banks, including the Reserve Bank of India, that manage the reserves are investing them primarily in short-dated U.S. government securities such as treasury bills. These highly liquid investments, however, offer low yields. The key question in India as well as in many similarly placed Asian countries is whether there are better methods of investing the reserves that will yield a reasonable return without compromising safety and liquidity. The issue has come into sharp focus following the decision by the Chinese monetary authorities to invest $3 billion — out of their estimated $1.2 trillion reserves — in Blackstone, a private equity firm based in New York. In India, where the clamour for a more profitable investment strategy has been growing even as the reserves keep piling up, the Chinese decision may seem significant.

However, no one has so far advocated deployment of even a small portion of India's reserves in private equity firms, hedge funds, and the like which even regulators and the generally better-informed investors in the West are finding to be opaque. In fact the Chinese decision might well have been guided by other considerations such as picking up stakes in American companies through the medium of private equity. China has six times India's reserves and the rate of accretion is faster than India's. Equally relevant is that China has been much better prepared to diversify its investment strategy. For quite some time now, a large part of the liquidity flowing from its huge trade surplus has gone into the domestic stock market fuelling an equity boom. Most important of all, the prevailing official mindset in India will not countenance any strategy that involves even a modicum of risk-taking. The way forward is to emulate countries such as Singapore and Kuwait by forming investment vehicles, which might be entrusted with the management of a small portion of reserves. It would be desirable to be totally transparent. Policy-makers as well as lay people should be briefed on the risk-return aspects of such a strategy.

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