india's forex mgmt compared to the best in the world

[Guest guest]

http://www.rbi.org.in/index.dll/36549?OpenStory?fromdate=05/29/03&todate=05/29/03&s1secid=1001&s2secid=1001&secid=4/9/0&archivemode=0

 

India’s Reserve Management policies are comparable to global best practices" - IMF

India’s management of foreign exchange reserves has generally been in accordance

with IMF guidelines and is comparable to the global best practices in this area.

In line with global developments, in the recent period, India’s reserve

management operations have become more transparent. The emphasis is on

efficient management of reserves. In areas like greater and more efficient use

of information technology, use of sophisticated risk management techniques like

Value at Risk (VaR), determination of optimal currency composition, sound

management of credit and market risks and the internal governance structure,

India’s policies are comparable with international best practices.

These were the major findings recorded in an Accompanying Document recently

published by the International Monetary Fund (IMF). The Document has been

published as a supplement to the IMF’s "Guidelines for Foreign Exchange Reserve

Management". The Guidelines were developed earlier by the Fund and were approved

by its Executive Board in September, 2001. The work on the Accompanying Document

was initiated at the instance of the Executive Directors of the Fund as a part

of the broader programme to strengthen the international financial

architecture, promote policies and practices that contribute to the stability

and transparency in the financial sector and reduce external vulnerabilities of

member countries. The Guidelines identify areas of broad agreement among

practitioners on reserve management principles and practices that are

applicable to a broader range of countries at different stages of development

and with various institutional structures for reserve management.

The Document has been developed based on the inputs, given by the reserve

management entities in 20 select countries, in the form of case studies. These

countries have been chosen in such a way as to represent countries at different

stages of economic and financial markets development and with different

institutional structures to illustrate the ways and means by which they have

developed capacities in the area of foreign exchange reserve management. India

was one of the countries selected for the study. Besides India, the other

select countries include Australia, Botswana, Brazil, Canada, Chile, Colombia,

The Czech Republic, Hong Kong, Hungary, Israel, Republic of Korea, Latvia,

Mexico, New Zealand, Norway, Oman, Tunisia, Turkey and the United Kingdom.

Observations regarding India’s Foreign Exchange Reserves Management

Commenting on India’s reserve management objective, the Document observes that

"maintaining a capacity to intervene in the markets to support the exchange

rate regime or to contain excessive volatility in the foreign exchange market",

as also, "to provide confidence to the markets and reduce their vulnerability to

financial crises" have been some of its important objectives. The Document

further observes that "India intervenes in the market to even out lumpy demand

or supply in thin markets and to prevent destabilising speculation while

facilitating foreign exchange transactions at market rates for all permissible

purposes. Liquidity is, therefore, an important consideration in reserve

management".

In the context of accountability, the Document observes, "In India, external

audit is conducted by independent external auditing firms". The Document has

also noted, "In addition to annual inspection by the internal inspection

department and external statutory audit, there is concurrent audit of the

reserve management operations. There is also a system of appointing, on an

annual basis, an external auditor to conduct special audit of the dealing room

transactions". On internal governance the Document states, "Strategic decisions

on currency composition and asset allocation are taken by the central bank in

consultation with the government".

As regards currency risk and currency composition of reserves, in the context of

management of reserves, the Document observes, "India considers the need to

maintain a large portion of reserves in the intervention currency, external

trade profile and potential strengths and weaknesses of the four major

currencies for diversification benefits". Further it states, "although India

has not divided the reserves portfolio into tranches, each currency benchmark

portfolio is divided into two components, one has a short duration and the

other a longer duration".

"India gives a small portion of the portfolio to external asset managers to have

access to and derive benefits from the information system and market research of

a widely diversified group of external asset managers. The relationship is also

used to train portfolio managers", the Document observes. Regarding stress

tests, the Document states that India has been undertaking exercises based on

stochastic models in order to estimate Liquidity at Risk.

General Findings of the Study

The country practices, according to these case studies, indicate that countries

hold reserves to support a range of objectives, the most common being the use

of reserves as a tool for exchange rate management or monetary policy in

addition to the reduction of external vulnerability. In almost all the cases,

maintaining a capacity to intervene in the market continues to be an important

objective even though countries with floating rate arrangements do not need to

intervene in the markets regularly; for these countries, the objectives of

holding reserves, according the Document, are for crisis prevention, for

providing confidence to the markets and act as a buffer to manage exchange rate

volatility.

The Document observes that the dominant objective of reserve management policy

has been "maintaining capacity to intervene in the foreign exchange markets, to

support the exchange rate regime or to contain excessive volatility in the

foreign exchange markets" in countries, such as, Brazil, India, Republic of

Korea, Latvia, Oman, Tunisia and Turkey; while countries like Colombia, the

Czech Republic, India, Israel, Republic of Korea and Turkey hold reserves to

provide confidence to markets and reduce their vulnerability to financial

crises.

While all the countries surveyed have reserves management policies that ensure

availability of adequate liquidity at acceptable cost, the emphasis has been

increasingly on the efficient management of the reserves in order to enhance

the returns (or to reduce the costs), while preserving the capital and ensuring

liquidity. On the other hand, it emerges from the case studies that over the

last few years, there has been a trend towards greater transparency in

disclosing information on reserves and reserve management policy and

performance.

Another observation made by the Document is that although India and Israel have

not divided the reserves portfolio into liquidity and investment tranches, each

currency benchmark portfolio is divided into two components in terms of short

and long duration portfolios.

Developments in the area of information technology have been quoted as a major

challenge for all reserve management entities and the level of sophistication

with which risk management function has been attended to in the recent years

has advanced significantly. From the Document it emerges that some of the

reserve management entities outsource the services of external asset managers

for managing reserves.

Full text of the Document is available on IMF Website

http://www.imf.org/external/np/mae/ferm/2003/eng/index.htm

Alpana KillawalaGeneral Manager

Press Release : 2002-2003/1215

Discover your Indian Roots at - http://www.esamskriti.com, 700 pictures, over

140 articles.To mail - exploreindia (AT) vsnl (DOT) net, to Un write

back.Long Live Sanatan / Kshatriya Dharam. Become an Intellectual

KshatriyaGenerate Positive Vibrations lifelong worldwide.Aap ka din mangalmaya

rahe or Shubh dinam astu or Have a Nice DayUnity preceedes Strength Synchronize

your efforts, avoid duplication.THINK, ACT, INFLUENCE, to Un write

back.Create Positive Karmas by being Focussed, controlling senses, will power &

determinationNever boasts about yr victory and successKnowledge, Wealth,

Happiness are meant to be sharedBe Open Minded, pick up what yu like from the

world

 

Stop cribbing, ACTION is what the Indian scriptures talk aboutTake the battle

into the enemy camp, SET THE AGENDA, be proactiveIn an argument, no emotions,

be detached, get yr facts right, then attack with the precision of a missile