I am no economist. Nor do I intend to be one. But I do keep an eye on all things money. And one thing cannot go unnoticed that India’s Forex Reserves have been growing steadily over the years.
India’s foreign exchange reserves recently crossed $620 billion. Here is a screenshot from the latest data (you check the latest foreign exchange reserve data here on RBI’s website):
This is the 4th largest reserve in the world after China ($3.3 Trillion), Japan ($ 1.38 Trillion), and Switzerland ($ 1.09 Trillion).
We also need to remember that in 1991, our forex reserves stood at only $1.2 billion – which were just enough to cover the imports for a couple of weeks. We had to borrow from IMF. Here is how our reserves have grown over the years:
Things are much more comfortable now. The forex reserves today are enough to cover 15 months of imports.
As per an article I read (link), the forex reserves are assets held by the central bank and comprise foreign currencies, bonds, bank deposits, gold, special drawing rights, and financial assets. Foreign currencies, the largest constituent of Indian forex reserves, are held in the form of treasury and institutional bonds. Forex reserves are a net of inflow and outflow through a country’s current and capital account, and need not necessarily be reflective of the positive earnings of the country.
But is this buffer of 15 months big enough for a country like ours?
People have different opinions. A cushion of 15 months isn’t small. But numerically speaking, we are lower than Switzerland (39 months); Japan (22 months), Russia (20 months), and China (16 months).
A big enough reserve provides the country with enough firepower to fight against future currency depreciation. And that is important for us as it helps minimize vulnerability to external and global crisis situations. If our currency Rupee (INR) suddenly starts depreciating against the US Dollar, then the RBI can sell its dollar reserves and buy the local currency in order to stop the depreciation to some extent.
But with a growing corpus (now $600 Billion+), there are bound to be discussions around whether the reserves are adequate and whether it should be managed in a different manner than it is being done currently.
I am not saying that the reserves can be used to fund domestic infrastructure projects as many people think it can be done. In an interview given by our RBI Governor (link), he rightly points out that “the reserves are not our own money. It is not that we have built it up by way of trade surplus. If we have reserves, we also have liabilities against them. Capital flows are a strong contributor to our reserves. We have to be watchful. Our current level of reserves gives us confidence, but we cannot be complacent.” Even the former RBI Governor pointed out some time back that “India needs forex reserves buffer to insulate itself from exchange rate volatility as we have ‘no friends’…So when you have no external support, you have to build your own support, which is why we started building the reserve buffer.”
What I am saying is that maybe, just maybe, there can be a different approach taken for managing a part of the reserves.
I am talking about having a Sovereign Wealth Fund (or SWF).
And a proper one at that.
We already have an entity called the National Investment and Infrastructure Fund (NIIF). It is a sort of domestic SWF that has managed to secure $4 billion of capital commitments as of now. Read more about it here and here.
I think that we have reached a stage that a small part of our forex reserves (of $600 Billion) can now be used to set up a Sovereign Wealth Fund. The money can be deployed strategically for the long term – just live we invest for our long-term goals. This alternative fund can be then used to diversify the portfolio and generate better and more desirable returns on investments.
Just have a look at the list of countries with sovereign wealth funds. Some of these are massive:
- Norway Government Pension Fund Global – $1.29 Trillion
- China Investment Corporation – $1.04 Trillion
- Kuwait Investment Authority – $692 Billion
- Abu Dhabi Investment Authority – $649 Billion
- Hong Kong Monetary Authority Investment Portfolio – $580 Billion
- GIC Private Limited – $545 Billion
- Temasek Holdings – $484 Billion
- Public Investment Fund – $430 Billion
- National Council for Social Security Fund – $372 Billion
- Investment Corporation of Dubai – $302 Billion
And due to their strategic investments, many of these countries have gradually but surely increased their country’s policy role in the world and earned decent long-term returns.
I remember that several years back, RBI had then had some reservations about setting up an Indian sovereign wealth fund as it wanted to have one out of the country’s budget and not from the forex reserves. But times have changed now I think.
How big should the Indian Sovereign Wealth Fund SWF be?
Consider this – From $620 Billion reserves, imagine if we set aside 5-10% at first, i.e. $30-60 Billion as a dedicated Indian Sovereign Wealth Fund (SWF).
And when compared to personal finances, you can consider the forex reserves of the country as your Emergency Fund.
But please don’t confuse the country’s forex reserves with the foreign exchange or currency market also known as forex. Many of you won’t know about it but its’ the biggest market in the world! I know someone abroad who works with forex brokers abroad and does quite well in forex trading. Just a word of caution – don’t think that forex trading is a get-rich-quick scheme as many advertisements may make you believe it. Also, whether you can do it in India or not is also questionable
Coming back to the Forex reserve being the emergency fund discussion – When you have too large an emergency fund, then you are compromising on the returns. So it’s best to have an adequately large emergency fund and then, invest prudently and with a long-term approach for the rest of the portfolio. Since we are talking about the country, we can have a larger reserve and then start small with Indian SWF.
There is also a view that SWFs are simply aggressive ways to manage a country’s forex reserves. Whatever it is, I think it might be a good time to consider setting up an SWF now.
Let’s see how this goes and when we get to see an Indian Wealth Fund. I am all in favor of it.