A study on various options for utilizing India s foreign exchange reserves

Abstract

This report looks at the various options that are available for investment of Foreign exchange reserves. We analyze in detail what amount of reserve is considered to be adequate globally and also look at it from India s perspective. The analysis is qualitative while looking at the various adequacy factors. We then look at the Cost and Benefits of holding a large amount of Forex reserves. We look at both Fiscal and Social cost. We then look at some of the most important options available to invest the forex reserves such as investing in Sovereign Wealth Funds (SWF), investing in infrastructure and lastly at prepayment of debt. We later take a quantitative look at Singapore s Temasek Holdings, as an example to understand what the Government did with their excess funds via the Sovereign Wealth fund. The reason for choosing Singapore is two-fold, firstly they have been lauded world over for their judicious use of excess funds and secondly because Temasek Holdings (a Sovereign wealth fund subsidiary of Singapore s ministry of finance) has published information on how their fund has grown over the years which provides us a good insight into what could have led to the increase in the investment in SWF. This study only analyses the information on various options available for Forex reserves and does not recommend which option to utilize. We look at the various pros and cons of investing in the various options. The report also looks at what were some of the important factors that explain Singapore s investment in their Sovereign Wealth Fund. Factors such as Current Account portion of Balance of Payments, Inflation, Exchange Rate and Number of Months of Import are the independent variables we use for this study and try to regress the changes in SWF with changes in these variables. Lastly we try to map these variables with that of India and see if we were to follow a similar pattern, what should be the amount that can be allocated from forex for SWF.