Falling $ lifts fx hoard by +$20 billon

Just over a week ago, the Reserve Bank of India (RBI) had released the salient details about the external sector for the April-December 2009 period and literally minutes after, it also placed in the public domain, the sources of variation in the foreign exchange reserves during this period. Read together and in conjunction with related other developments, they bring to spotlight many fascinating nuggets of information.On balance of payments basis, the accretion to foreign exchange reserves as at the end of the first nine months of 2009-10 was of the order of $11.3 billion

• The  depreciation of the dollar against most other currencies boosted the forex kitty by a staggering $20.18 billion
•    Thus, of the total increase of $31.48 billion in forex, a major portion — 64% — stemmed from the weakening greenback
•  On November 3, 2010, RBI had purchased 200 tonnes of gold from International Monetary Fund (IMF), valued at $6.7 billion. This directly has no impact of the total forex, since this implies merely a substitution of foreign currency assets by gold. But, since gold too has appreciated  after this date and the value of erstwhile gold stocks have to risen due to surging prices of the yellow metal, valuation gains have arisen not only from the setback to the dollar but also from increased quantum of official gold stocks as well as the firming up tendency of this precious metal
• As the fiscal year 2009-10 opened, the proportion of gold stocks to the forex was 3.8%; this proportion shot up to 6.1% during the week ended November 6 (the week during which RBI had made the gold purchases) and by December 31, 2009, the share of gold rose higher to 6.5%.
• Even in regard to the increase of $11.3 billion in forex on BoP basis, role of the transactions in special drawing rights cannot be ignored. This is because India’s forex kitty also benefitted from a significant allocation of SDRs by IMF in two tracnches; in late August and early September, we had received SDRs 3297.1 million, equivalent to $5223 million.

The RBI presents the data relating to BoP in factual terms and often what it has to say is a mere verbalisation of figures set out in a tabular format.

In the process, sometimes what is important is omitted, though the same information can be accessed from other publications of the RBI. In dealing with the external sector developments, therefore, it is strange to find that the Central does not allude to the unprecedented gold purchases that have led to shift in the composition of the forex during the period under reference - that is, April-December 2009 - or to the fact that, the bullish fervour in gold is also a factor in the valuation gains.

Similarly, there is no mention of the allocation of SDRs in the BoP particulars, though in the statement of the sources of variation in foreign exchange reserves, a foot note to “ other items in capital account” there is only a cryptic mention of SDR allocations. When the amount involved is more than $ 5 billion, it should have been highlighted.

An idea of the shift in the pattern of forex can be had from the fact that, as of end March 2009, gold stocks were worth $9.57 billion and by end-December, they nearly doubled to $18.29 billion.
The  SDRs in the forex kitty at these points of time were $5.17 million and $1 million.

As per RBI practice, gold is valued at the average of the London price during the month and SDRs in terms of dollars at exchange rate released by the IMF.

The foreign exchange assets are valued at the exchange rate of the dollar against other major currencies and since they compose bulk of the forex kitty, dollar depreciation has boosted the value of these assets over the nine months ending December 2009. No wonder that the  valuation gain was substantial at $20185 million.
But, during these months, gold has also been generally tracing an upward trajectory. The monthly average price of gold in London has surged by 22.8% from $924.27 per troy ounce in March 2009 to $1,134.72 in December 2009 and official gold holdings had thus benefitted from this appreciation in the yellow metal.

In fact, when RBI had bought 200 tonnes of gold in early November 2009, it was  at an  indicative price of $1041.82 per ounce. The average price had risen to $1127.04 in November and further to $1134.72 in December. This is mirrored in the higher value of gold holdings in terms of dollars in the overall forex position by December vis-à-vis end March.

Thus, the main prop to the BoP during the first nine months of 2009-10 was provided by valuation gains.

At $20.18 billion, they compare favourably with other sources of accretion to forex such as net foreign direct investment ($16.53 billion) and net portfolio investment ($23.6 billion) and far exceed the net inflow from such sources as external aid, external commercial borrowings and short-term trade credit.

This fortuitous element in the strong external payments situation cannot be ignored as the position was exactly the reverse during the April-December 2008 period, when valuation loss to the tune of $33.37 billion, coupled with a setback of $20.38 billion on BoP basis, had led to an erosion of a staggering $53.75 billion in our foreign exchange reserves. It is also useful to remember that the current account is still mired in red ink, and at over $30 billion cumulatively during the first three quarters of 2009-10, we are still not out of the woods as far as the BoP is concerned.