Even as domestic interest and inflation rates shot through the roof, the country's $303 billion-plus (Rs 13,63,000 lakh crore) forex reserves fetched a measly 2.09% return for the year ended June, 2010, which if adjusted against inflation at 8.31%, is a negative return on the asset.
This has happened so because the Reserve Bank has chosen to invest those monies in foreign markets/assets and not in the domestic market/assets. However, it has to be noted that the RBI could not have done otherwise under the prevailing rules governing foreign exchange reserves management.
"The rate of earnings on foreign currency assets (FCAs) and gold, after accounting for depreciation, decreased from 4.16% in July, 2008, to June, 2009, to 2.09% in July, 2009, to June, 2010, reflecting the generally low global interest rate environment," the RBI's half-yearly report on management of forex reserves released last week said.
Accordingly, RBI could only get an interest yield of a paltry Rs 27,000 crore from this 2.09% interest rate -- which is even way below the return rate on savings accounts -- on this mound of cash. However, had the central bank chosen to deploy these funds in the country, it would have fetched as much as 4.5 times more return at Rs 1,21,900 crore at the prevailing interest rates.
Contrast this with the current interest rate in the country, which had been spiked as many as eight times since March, 2010, and adjust this with the current inflation of 8.31%. A 390-day term deposit gets you as much as 9% or more return today and even saving bank rates offer a higher return of a full 3.50%.
Headline inflation, after hovering in high double digits, came down to 8.31% in February, while food inflation for the third week of March stood at 9.5%.
But both these numbers were in high double digits for most part of the last fiscal, forcing the RBI to raise short-term borrowing and lending rates as many as eight times since last March.
After the recent mid-quarter review, the current short-term lending repo rate is pegged at 6.75%, while the short-term borrowing rate, or reverse repo, stands at 5.75%. The bank rate and cash reserve ratio are kept at 6% each.
As late as March 17, the central bank ramped up the repo and reverse repo rates by 25 basis points and raised its inflation forecast for FY'11 to a high 8%.
According to the existing guidelines, the RBI parks the forex reserves abroad, primarily in the West. But during the period under review, interest rate regimes in these countries were at historic lows, varying between 0.25 and 1%.
After the recent global financial crisis, the US Fed had slashed its benchmark interest rate to a record low of 0.25 percent, while the European Central Bank's benchmark rate is also at a record low of 1%. The Bank of England holds its key rate at a low 0.50%.
Accordingly, the low rates prevailing in these countries led to very poor returns on the funds that the RBI parked in those markets.
Though an analyst has admitted that RBI cannot change its forex deployment policy every six months for better returns, he pointed out that the central bank has to do something in this regard as the current return of 2.09% is very poor from any angle.
As of the end of September, 2010, of the total foreign currency assets of $265.2 billion, $146.4 billion was invested in securities, $113.6 billion was deposited with other central banks, BIS and the IMF and $5.2 billion were placed with the external asset managers, RBI report said.
"Except fixed deposits with the BIS (Bank of International Settlement), foreign commercial banks and central banks and securities issued by supra-nationals, almost all other types of investments are in highly liquid instruments, which could be converted into cash at short notice," it said.
Forex reserves grew significantly since 1991. Reserves, which stood at $5.8 billion in March, 1991, rose to $54.1 billion by March, 2002, after which it rose steadily reaching $309.7 billion in March, 2008. But, it declined to $252 billion in March, 2009, and rose again to $292.9 billion in September, 2010, it said.
The RBI held 557.75 tonnes of gold, forming about 7% of the total forex reserves in value terms as on September 30, 2010. Of these, 265.49 tonnes are held abroad (65.49 tonne since 1991 and further 200 tonne since November 2009) in deposits/safe custody with Bank of England and the BIS.
With a view to bring about more transparency and enhancing the level of disclosure, way back in February, 2004, the Reserve Bank had commenced a process of compiling half- yearly reports on forex reserve management and placing them in the public domain with a lag of about three months.
The first such half-yearly report for September, 2003, was released in February, 2004. Since then, reports are prepared every six months with reference to position as of March 31 and September 30 annually with a time lag of three months.