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RBI moots national liquidity policy

BS Banking Bureau in Mumbai

The Reserve Bank of India has mooted a new concept of "national liquidity" for managing the country's forex reserves. This policy takes into account not only the sovereign and publicly guaranteed external obligations but also the maturity and currency mismatches of the private sector.

The country's forex reserves touched $60.639 billion on August 16, 2002. The RBI is planning to pile up more as it aims at building a forex reserves chest as a defence against unpredictable flows. It is keen on building reserves as it wants to gain economies of scale.

A high level of reserves is necessary to ensure that even if there is prolonged uncertainty, reserves can cover the 'liquidity at risk' on all accounts over a fairly long period, the RBI annual report said.

The size of the reserves should not be related to the quantum of imports or the current account deficit in emerging economies. The reserve management, according to the RBI, has reflected risks associated with different types of flows and requirements other than the developments in the current account.

According to the RBI, a two-fold increase in the size of annual capital flow will be required to finance the average current account deficit of 2.8 per cent - as has been projected in the 10th Five Year Plan. Piling of a high level of reserves is important in this context.

In emerging markets, India is among the top reserve holding countries. The fiscal year 2001-02 saw the maximum accretion of forex reserves at $11.8 billion. The outstanding forward liabilities of the RBI has been bought down to $0.4 billion at the end of March 2002 as against $1.3 billion the pervious year.

The RBI's reserve management policy is that the quantum of reserves in the long run should be in line with the growth of the economy and the size of risk-adjusted capital flows leaving aside short-term variations in reserve levels.

The RBI has also suggested a 'liquidity at risk' rule that would take into account the foreseeable risk that a country could face.

Dealing at a theoretical level, the RBI said the direct financial cost of holding reserves is the difference between interest paid on external liabilities of public and private sectors and return on external assets. But such cost has to be treated as insurance premium to assure and maintain confidence in the availability of liquidity.

"The benefits of such a premium are not merely in terms of warding off risks but also in terms of better credit rating and finer spreads while contracting debt," the RBI said.

The forex reserves policy is to enhance the capacity to intervene in the forex markets, limit external vulnerability by maintaining foreign currency liquidity to absorb shocks and provide confidence to the external markets, it said.

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RBI Annual Report 2001-02
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