India's central bank shifts slowly away from dollar

Reserve Bank of India Takes Liking to Yuan, Australian Dollar

By Gayatri Nayak
Economic Times (India Times), Gurgaon
Monday, August 4, 2008

http://economictimes.indiatimes.com/Markets/Forex/RBI_takes_a_liking_to_...

MUMBAI -- The Reserve Bank of India is gradually shifting away from hard currencies such as the dollar, the yen, the euro, and the pound within its portfolio of foreign exchange reserves to other currencies.

While the central bank does not disclose the currency break-up in reserves, it is understood that it has begun investing in assets denominated in Chinese yuan and Australian and Canadian dollars.

According to the latest RBI data, the share of such currencies, also called the SDR basket currencies, has touched a new low of 91.38 per cent as of June 30, down from 99.81 per cent in 2001. The share of non-SDR, comprising the rest of the currencies, has touched a new high of 8.62 per cent.

"The shift in the preference has got a lot to do with the fall of the dollar against major global currencies over the past few years. There is also a thrust on moving from low-yielding assets to high-yielding assets. And that would involve diversification of the dollar. But the shift could be more towards euro and currencies in the SDR basket than to other currencies. However, among other currencies, there could be an interest in the yuan as China is emerging as a large trading partner for many countries," said a regional economist with a global investment bank.

This holds true for India. China was India's largest trading partner in April 2007-February 2008 with a turnover (exports plus imports) of close to $34 billion compared to a turnover of about $31 billion with the United States in the same period. However, it is likely that a substantial amount of both the export and import contracts with China too could be invoiced in other hard currencies such as the dollar. Hence, the importance of the dollar cannot be discounted, say currency strategists.

Reserve Bank governor Y.V. Reddy, in an address at the Bank for International Settlements, said central banks have been cautious in diversifying their reserves, though there has been a quest for higher returns. This is most likely the result of progressively rising returns, he said. Consequently, the financial return on free reserves at the margin could be far higher than the average return, he added.

But unlike treasury managers at commercial banks, the RBI is more concerned about liquidity of its forex assets than return. This is because, as the custodian of the forex currency assets, the central bank has to be prepared for contingencies and provide the forex as and when required by the various constituents of the market. As for foreign currency inflows, most of the inflows in Asian markets are in dollars and the central banks cannot ignore the dollar completely, said Timothy J Bond, Merrill Lynch chief economist for Asia-Pacific. Yet, there may be some justification in diversifying the forex asset-base by the central banks. Many in Asia hold reserves way above several traditional adequacy measures.

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