RBI may switch to euro gilts

Falling dollar makes holding US paper costly

The Reserve Bank of India (RBI) and the finance ministry are exploring the option of replacing a part of the central bank's investments in short-term US securities with European gilts.

This marks a major departure from the country's dependence on dollar-based instruments and is seen as a means of proactively managing the fast-growing forex reserves of $106.6 billion.

The proposal is in response to the steady depreciation of the dollar and the strengthening of the Euro against the rupee between April 2003 and February 2004.

Change of mind

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• The RBI and the finance ministry are considering replacing a part of the central bank's investments in short-term US securities with European gilts
• The move is in response to the steady depreciation of the dollar and the strengthening of the Euro against the rupee
• The traditional heavy exposure to dollar instruments has resulted in exchange losses for the RBI
• A transfer to the Euro market will also earn the central bank higher returns

In April 2003, a dollar earned Rs 47.50. This is down to Rs 45.23, representing a near 5 per cent depreciation. In contrast, a Euro, which earned Rs 51.70 at the start of the fiscal, is now worth Rs 57.60, an 11.4 per cent appreciation.

The traditional heavy exposure to dollar instruments has resulted in exchange losses for the central bank. In the last financial year as on June 30, 2003, RBI had made a provision of Rs 567.25 crore in the Exchange Equalisation Account, which represents provision for exchange losses due to forward commitments.

In June 2002, the provision on this account was only Rs 51.50 crore, and Rs 49.46 crore as on June 30, 2001.

A transfer to Euro market would also earn the central bank higher return. US Treasury bills offer marginal returns of 1.5 to 2 per cent, compared with about 4.5 per cent on Euro-denominated securities, ( yield on the UK 10 year gilts were 4.47 per cent in February, 2004).

"Forex reserves are deployed within a narrow band," says a finance ministry official, adding that a small change can thus make a big difference.

India now holds the world's sixth largest reserves and the third largest in Asia, behind Japan ($673.53 billion in December 2003) and China ($403.3 billion). The latter's forex reserves increased 40.8 per cent at the end of calendar 2003.