Dollar wise, pound foolish

A joint parliamentary committee has already commented extensively on the role played 8212; or not played 8212; by the Reserve Bank during the Madhavpura Bank and the City Cooperative Bank, Lucknow, crises. Again, as I have had occasion to point out in these columns, the Reserve Bank fell on its face when it came to monitoring overseas corporate bodies OCBs operating out of Mauritius. This cost India approximately a billion dollars. But the truly colossal failure has been the negligence with which the Reserve Bank managed the foreign reserves.

September 11, 2001 was a watershed event. At that point India8217;s foreign exchange reserves were roughly 42.5 billion. The figure is deliberately given in the American currency since the Reserve Bank chose to have almost all its holdings in dollars. A small amount has always been put in gold. Until March 2003, the Reserve Bank did nothing to modify the policy of putting all its eggs in the American basket. Nobody at its Mumbai headquarters noticed that yields on 10-year US Treasury bonds had declined from 6.8 per cent in the year 2000 to below 3.4 per cent, a low point not seen for 45 years.

Was there was an alternative? The American dollar is the world8217;s reserve currency of choice, is it not? But there has been an option since 2001 8212; the Euro, the European Community8217;s single currency. Look at what might have happened had the Reserve Bank diversified its holdings even as late as September 2002. India8217;s reserves stood at 60 billion in that month. By then, currency traders were predicting that the dollar was due for a tumble. The central banks in several nations heeded this warning, prudently diversifying by buying Euros. The Euro was worth just 0.9688 at the end of August 2002; today it takes 1.1670 to buy a single Euro 8212; a change of 20.5 per cent.

If the Reserve Bank deemed the Euro an untested currency, did it consider the British pound? The British chose not to join the Euro zone in 2001. That too has appreciated vis-a-vis the dollar, from 1.5188 in August 2002 to 1.6350 today 8212; a positive change of 7.7 per cent. That is a more modest increase than the Euro, but it would still have offered better returns than by hanging on to the dollar.

Assume that the Reserve Bank had been wiser in September 2002. Had it placed just a third of the reserves 8212; then worth 20 billion 8212; in Euros and another one-third in the British sterling, what would have been the result? Very simply, the value of the reserves would have risen by 6 billion!

But money continued to pour in after September 2002, about 15 billion. Had the Reserve Bank used this amount too in the proportions stated above, the value of the Indian reserves would have risen by another 1.5 billion. In other words, the Reserve Bank8217;s foolishness has led to this country losing 7.5 billion in potential gains. This calculation, by the way, does not take into account the interest lost because higher yields were available on assets denominated in Euros and pounds!

This was not all. A chunk of the reserves was purchased locally by the Reserve Bank in an attempt to keep the rupee deliberately low against the dollar. The argument was that the weaker rupee would aid exports. Since the dollar sank anyway, the Reserve Bank is likely to end up losing about Rs 2 on every dollar it purchased.

It is nobody8217;s case that the Euro and the pound will stay at these high levels. The housing bubble may burst in Britain. The Europeans may be crushed by the burden of their idiotic Common Agricultural Policy, especially after the new members from eastern Europe join the party. France and Germany continue to suffer 10 per cent unemployment rates.

But the professionals at the Reserve Bank are paid to consider all this. If managing India8217;s reserves requires nothing more intellectually taxing than buying dollars, do we really need them? True, the Reserve Bank diversified its holdings as of March 2003 8212; a decision which has already been about 3 billion to the good for us 8212; but even that was thanks only to prodding from North Block.

Surely 7.5 billion is no small amount. Add the 1 billion lost to the Mauritius-based overseas corporate bodies, and we end with the staggering sum of 8.5 billion, losses which India can ill afford. Surely somebody at the Reserve Bank should be held responsible for such negligence.