Dollar inflow may hit return ratios for RBI and other currency holders

MUMBAI: As India's foreign-exchange kitty swells amid strong dollar inflows, the Reserve Bank of India and other holders of the US currency are investing a part of their dollar funds in instruments that offer relatively lower returns, a move that will widen the investment income deficit in the current account.

Indian investors, predominantly the RBI, increased their holdings of US treasury securities to $91.2 billion in January, according to the latest US treasury data. This is more than what foreign portfolio investors have put into Indian government and corporate debt, $51.12 billion, or Rs 3.07 lakh crore, according to data from the National Securities Depository.

While India hiked its exposure by $10.2 billion since August, China pulled out $30 billion in the same period. India increased its exposure to US treasuries by $20 billion as of January in the current financial year. A bulk of the investments was by the RBI, which accumulated reserves by mopping up foreign currency inflows.

The trend of investing in US treasury securities could pose pressure on the balance of payments because the returns that India earns would be much lower than what it needs to pay foreign investors, which could widen the investment income deficit in the current account.
Returns on US treasuries are a menial 1.99 per cent, while India pays an average of 8 per cent on investments in government bonds.

Foreign investors have pumped in over $45 billion in Indian debt and equity and the RBI has added $37 billion to its foreign exchange reserves so far in this financial year. India's foreignexchange reserves increased by $4.26 billion to a record $339.99 billion in the week ended March 20, the RBI said last week.

India's strategy may be in line with most global central banks that are opting for dollar assets and moving out of the euro, which has weakened significantly against the dollar. "Our analysis of the IMF Cofer (composition of foreign exchange reserves) data finds further evidence that central banks have been reducing their weighting of euro in forex reserves, now holding the lowest level of euro in reserves since 2002," Morgan Stanley said in a currency report.

"Central banks' forex interventions and consequent deployment of reserves are conventionally cloaked in a lot of opacity," said Saugata Bhattacharya chief India economist at Axis Bank. "The choice of instruments is dictated not only by respective yields but also the risk appetite and trading liquidity. The details once again highlight the costs of intervening in currency markets."

Acentral bank's decisions on investing its forex reserves are determined by concerns over safety and liquidity. The RBI has to strike a balance between investing in safe and liquid overseas assets that have relatively lower interest rates and selling its holdings of high-yielding government bonds to mop up excess liquidity in the domestic market.