The Reserve Bank of India publishes half-yearly reports on management of foreign exchange reserves as part of its efforts towards enhanced transparency and levels of disclosure. These reports are prepared half yearly with reference to the position as at end-March and end-September each year. The present report (37th in the series) is with reference to the position as at end-September 2021.RBI Report on Management of Foreign Exchange Reserves–Oct 27, 2021
1. Objectives of Reserve Management
The guiding objectives of foreign exchange reserve management in India are similar to those of many central banks in the world. The demands placed on the foreign exchange reserves may vary widely depending upon a variety of factors including the exchange rate regime adopted by the country, the extent of openness of the economy, the size of the external sector in a country’s GDP and the nature of markets operating in the country. While safety and liquidity constitute the twin objectives of reserve management in India, return optimization is kept in view within this framework.
2. Legal Framework and Policies
The Reserve Bank of India Act, 1934 provides the overarching legal framework for deployment of reserves in different foreign currency assets and gold within the broad parameters of currencies, instruments, issuers and counterparties. The essential legal framework for reserve management is provided in sub-sections 17(6A), 17(12), 17(12A), 17(13) and 33 (6) of the above Act. In brief, the law broadly permits the following investment categories:
deposits with other central banks and the BIS;
deposits with commercial banks overseas;
debt instruments representing sovereign/sovereign-guaranteed liability with residual maturity for the debt papers not exceeding 10 years;
other instruments / institutions as approved by the Central Board of the Reserve Bank in accordance with the provisions of the Act; and dealing in certain types of derivatives.
3 Risk Management
The broad strategy for reserve management including currency composition and investment policy is decided in consultation with the Government of India. The risk management functions are aimed at ensuring development of sound governance structure in line with the best international practices, improved accountability, a culture of risk awareness across all operations, efficient allocation of resources and development of in-house skills and expertise. The risks attendant on deployment of reserves, viz., credit risk, market risk, liquidity risk and operational risk and the systems employed to manage these risks are detailed in the following paragraphs.
3.1 Credit Risk
The Reserve Bank is sensitive to the credit risk it faces on account of the investment of foreign exchange reserves in the international markets. The Reserve Bank’s investments in bonds/treasury bills represent debt obligations of highly rated sovereigns, central banks and supranational entities. Further, deposits are placed with central banks, the BIS and commercial banks overseas. RBI has framed requisite guidelines for selection of issuers/ counterparties with a view to enhancing the safety and liquidity aspects of the reserves. The Reserve Bank continues to apply stringent criteria for selection of counterparties. Credit exposure vis-à-vis sanctioned limit in respect of approved counterparties is monitored continuously. Developments regarding counterparties are constantly under watch. The basic objective of such an on-going exercise is to assess whether any counterparty’s credit quality is under potential threat.
3.2 Market Risk
Market risk for a multi-currency portfolio represents the potential change in valuations that result from movements in financial market prices, for example, changes in interest rates, foreign exchange rates, equity prices and commodity prices. The major sources of market risk for central banks are currency risk, interest rate risk and movement in gold prices. Gains/losses on valuation of FCA and gold due to movements in the exchange rates and/or price of gold are booked under a balance sheet head named the Currency and Gold Revaluation Account (CGRA). The balances in CGRA provide a buffer against exchange rate/gold price fluctuations. The dated foreign securities are valued at market prices as on the last business day of each week and month and the appreciation/depreciation arising therefrom is transferred to the Investment Revaluation Account (IRA). The balance in IRA is meant to provide cushion against changes in the security prices over the holding period.
3.2.1 Currency Risk
Currency risk arises due to movements in the exchange rates. Decisions are taken on the long-term exposure to different currencies, depending on the likely movements in exchange rates and other considerations in the medium and long-term. The decision making procedure is supported by reviews of the strategy on a regular basis.
3.2.2 Interest Rate Risk
The crucial aspect of the management of interest rate risk is to protect the value of the investments as much as possible from adverse impact of interest rate movements. The interest rate sensitivity of the portfolio is identified in terms of the benchmark duration and the permitted deviation from the benchmark.
3.2.3 Liquidity Risk
Liquidity risk involves the risk of not being able to sell an instrument or close a position when required without facing significant costs. The reserves need to have a high level of liquidity at all times in order to be able to meet any unforeseen and emergency needs. Any adverse development on the external front would pose a demand on our forex reserves and, hence, the investment strategy needs a highly liquid portfolio. The choice of instruments determines the liquidity of the portfolio. For example, in some markets, treasury securities could be liquidated in large volumes without much distortion of the price in the market and, thus, can be considered as liquid. Except fixed deposits with the BIS/ commercial banks overseas / central banks and securities issued by supranationals, almost all other types of investments are highly liquid instruments which could be converted into cash at short notice. The Reserve Bank closely monitors the portion of the reserves, which could be converted into cash at a very short notice, to meet any unforeseen/ emergency needs.
3.3 Operational Risk and Control System
In tune with the global trend, close attention is paid to strengthen the operational risk control arrangements. Key operational procedures are documented. Internally, there is total separation of the front office and the back office functions and the internal control systems ensure several checks at the stages of deal capture, deal processing and settlement. The deal processing and settlement system, including generation of payment instructions, is also subject to internal control guidelines. There is a system of concurrent audit for monitoring compliance in respect of the internal control guidelines. Further, reconciliation of accounts is done regularly. In addition to internal audit and independent monitoring, the financial accounts are audited by external statutory auditors. There is a comprehensive reporting mechanism covering significant areas of activity/ operations relating to reserve management. These are provided to the senior management periodically, at frequent intervals, depending on the type and sensitivity of information. The Reserve Bank uses SWIFT as the messaging platform to settle its trades and send financial messages to its counterparties, custodians of securities and other business partners. International best practices with respect to usage and security of SWIFT system are followed. All the necessary upgrades were timely implemented in the SWIFT Alliance Access system along with strict compliance with all the mandatory security control measures as recommended by SWIFT.
4 Transparency and Disclosures
The Reserve Bank has been making available in the public domain data relating to Foreign Exchange Reserves, its operations in foreign exchange market, position of the country’s external assets and liabilities and earnings from deployment of Foreign Currency Assets and gold through periodic press releases of its Weekly Statistical Supplements, Monthly Bulletins, Annual Reports, etc. The Reserve Bank’s approach with regard to transparency and disclosure closely follows international best practices in this regard. The Reserve Bank has adopted the Special Data Dissemination Standards (SDDS) template of the IMF for publication of the detailed data on Foreign Exchange Reserves. Such data are made available on monthly basis on the Reserve Bank’s website.