RBI told to examine forex sale

Proposal likely to feature in the Budget for 2006.

The Prime Minister's Office has asked the Reserve Bank of India (RBI) to explore the possibility of initially using 5 per cent of the country's foreign exchange reserves for financing infrastructure projects.

The move comes despite a section in the finance ministry expressing reservations about the proposal mooted by Planning Commission Deputy Chairman Montek Singh Ahluwalia, who had suggested using $5 billion of the forex reserves every year for the next three years.

Using 5 per cent of the country's foreign exchange reserves will amount to about $6.5 billion as the total reserves were $131 billion on December 24. However, this includes gold and special drawing rights. Foreign currency assets alone were to the tune of $125 billion.

According to banking sources, the government has asked the RBI to work out the modalities for using the reserves. It will be done as an experiment and the monetary implications will be observed to decide on a course of action. The scheme was likely to feature in the Budget for 2006, the sources said.

The RBI, it is believed, is not enthusiastic about the proposal. The process will involve RBI handing over 5 per cent of the reserves to the government. The central bank will sell the dollars in the market to generate rupees. The funds then can be used as long-term investments for infrastructure projects.

The foreign exchange reserves of over $130 billion are equivalent to more than 12 months of imports. This is much higher than the general yardstick of holding reserves equivalent to six months of imports. RBI Governor YV Reddy has, however, time and again reiterated that there are no fixed targets for maintaining reserves.

With the continuous decline of the dollar, there is a gradual loss in the rupee-denominated value of the forex reserves. And although the Federal Reserve has hiked its base rate to 2.25 per cent in five phases since June 2004, the US bond market has not seen a proportional jump in interest rates. The 10-year US bond is now hovering at 4.24 per cent, up from 3.6 per cent last year.

Finance ministry officials said the use of reserves was not a viable option as it would push up the rate inflation by raising money supply.

They also pointed out that the Centre would find it difficult to meet the deficit reduction targets set out by the Fiscal Responsibility and Budget Management Act.

The officials said there were quite a few funding mechanisms, like the Rs 50,000 crore fund for infrastructure, which had barely been used.

"It made sense if there was a liquidity squeeze in the economy. But that is not the case at the moment," a finance ministry official said.

A final decision on using the reserves is to be taken by Prime Minister Manmohan Singh in consultation with Finance Minister P Chidambaram. The finance minister had recently said he would wait for some time before discussing the matter with Singh.

Banking sources said the return on investment of forex reserves came second to safety. However, if the reserves can be lent profitably and at a higher rate, there is no harm in experimenting with the idea.

International Monetary Fund, in its Article IV meeting with the RBI had conveyed that the government could issue a 10- year bond to mop up the surplus liquidity from the system. These funds could then be used for infrastructure projects, instead of disturbing the foreign exchange reserves.

(With inputs from Our Economy Bureau)