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Praxis The Reserve Bank of India's management of foreign exchange

Urban Pulse reserves has received plaudits from many observers, including

Brand Quest the IMF. The central bank has, however, erred on the side of

The New caution. "Better safe than sorry" seems to be its guiding
Manager mantra. I have observed earlier in these columns, in my review
of the RBI's Annual Reports, that the returns the central bank
Stocks gets on its reserves are low in comparison to those obtained by
such countries as Singapore.

Quotes

SE Diary The accounts for 2004-05 published in the RBI Annual Report

Scoreboard show that the rate of return on foreign exchange assets earned

Open-End Mutual in 2004-05 stood at 3.2 per cent before accounting for
Fund depreciation on securities. After depreciation, the report says,
the return in 2004-05 was 3.1 per cent. Thus, on foreign
Cross Currency currency assets amounting to Rs 5.75 lakh crore of rupees, the
RBI earned the rupee equivalent of roughly Rs 17,000 crore.

Rates
Let us compare this with what the Singapore Government
Shipping earns on its investments of foreign exchange reserves, which
also amounted to $128 billion in May. The Government
Investment Corporation (GIC) of Singapore, which manages

Ports
these investments, recently declared its results. Its Chairman,
the venerable Mr Lee Kuan Yew, its former Prime Minister and
Archives current Senior Minister, pointed out that in each of the 25
years since its inception, it has earned a return of 9.5 per cent

Yesterday a year, in US dollar terms. Compare this with the 3.1 per cent

Datewise our reserves have earned!

Resources

In Focus Just imagine if the RBI had followed the island-state's example,

In Depth our national economy would have earned a whopping six

http://www.thehindubusinessline.com/2006/07/24/stories/2006072400440900.htm 16-11-2007
The Hindu Business Line : Following the Singapore model Page 2 of 3

percentage more a year. In one year alone, it would have

earned Rs 30,000 crore more, which would have helped amply
finance many of Mr P. Chidambaram's schemes. All that it
needs is more imaginative and, at the same time, careful
Search investment of at least a substantial part of the foreign currency
assets through an investment vehicle on the lines of GIC.
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Singapore example

The Hindu
As Mr Lee, who has been Chairman of GIC from its inception,

Business Line
observes in his statement, Singapore's example has been

Sportstar
infectious. China and South Korea have, he says, already

Frontline
copied its modus operandi. The important point is that GIC

The Hindu
eBooks invests the currency reserves in the equity and bond markets

The Hindu of the developed and developing world instead of restricting
Images their deployment to US government securities.

GIC, Singapore, also has a real estate investment arm which

holds valuable real estate investments in the developed world.
The investment is also partly co-managed by leading
investment bank Goldman Sachs.

What does it take for India to follow the Singapore model?

Obviously, it requires a change in mindset. Safety is, after all,
the watchword of central bankers. But, at the same time, the
responsibility to secure a decent and safe return cannot be
abjured. The RBI has definitely seen light at the end of the
tunnel, as is seen from one of Governor Reddy's recent
statements in New York, published in the RBI Bulletin.

Referring to the management of forex reserves, Dr Reddy

pointed out that as the reserve level rises, it is possible to
diversify the portfolios and, increasingly, there can be an
emphasis on returns at the margin. He makes the point that
when the level of reserves exceeds that of foreign liabilities,
they become a part of national wealth and not "reserves" as
such. (I presume Dr Reddy is referring to external debt mainly
and not to the accumulated liabilities represented by FII and
FDI investments.) "In such a case", he says, you can create a
separate corporation, as Singapore has done, and do the
wealth management.

But we have not reached the stage where our external assets
are far higher than external liabilities to be able to treat it as
purely a wealth management issue. We are in the intermediate
stage. I do not quite agree with the Governor's views that we
are far from the stage where the wealth has to be managed as
such. The external debt to reserve ratio is around 1.

In fact, I would argue that when the assets are less than
liabilities, we have to be even more careful about the returns
being adequate because as returns become less, the liabilities
had to increase.

There is obviously a change of mindset and I hope

impediments are not put in the way of the RBI's promised
innovation in forex reserves management.

Change governance style

In attempting to follow Singapore example, we should not

merely stop at creating a GIC, India. It is the whole style of
governance, of incentives and human relations that determines
the high quality of the GIC's returns. The body is singularly
free of any government interference. No question of directed
investments in specific shares. The Government of India too
has to learn to abide by a policy of non-intervention with the
new public sector enterprise, which, in a sense, should enjoy
the autonomy inherent in a central bank entity.

I can hear critics observe that this is all a pipedream. We have

no tradition of letting public sector entities act autonomously.
Obviously, this has not been true of the revitalised UTI, which
has achieved significantly robust returns as a mutual fund. So
has SBI Mutual Fund. Given the political will and compulsions
to achieving good returns with safety, the proposed
Government Investment Corporation of India will also do a

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The Hindu Business Line : Following the Singapore model Page 3 of 3

good job.

Mr Lee was particularly emphatic that the GIC of Singapore

under his stewardship had achieved returns of 9 per cent, i.e. 5
per cent above the global inflation rate. He was particular
about the care taken to ensure that Singapore's savings did not
suffer any erosion in value. GIC, Singapore, does offer a useful
model that India can adopt with suitable modifications.

Safeguards

It is obvious that what operates in Singapore may not translate

too smoothly in India. It behoves Dr Y.V. Reddy to consult his
experts, both within and outside the RBI, about the safeguards
he would like to impose on such investments. Only, he should
take care that it is not too many safeguards and no
accelerator.

Whether the RBI will try to follow the aggressive model

adopted by Singapore in respect of investments in real estate
and hedge funds is a matter worth further exploration.

Dr Reddy will, of course, tread carefully lest the nest-egg be

busted. There are risks in deploying funds in real estate. There
may be no buyers for the distressed real estate assets. Limits
will, no doubt, be laid on such deployment.

Governor Reddy's statement in New York shows he is willing to

initiate change. He has rightly put limits on himself. It is
reasonable to expect that he will carry out his investment
function with due care to safety and returns — in the same way
as he is discharging his overall responsibilities. The Singapore
way is the way to go, provided we learn to do it in the style
that the Singapore GIC functions.

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http://www.thehindubusinessline.com/2006/07/24/stories/2006072400440900.htm 16-11-2007