The Hindu Business Line : Following the Singapore model

Singapore, which boasts roughly the same level of forex reserves as India does, has invested them so wisely that it earns nearly three times the returns India gets. It is time the RBI followed the island-state's more aggressive model, of course with safeguards in place.

The Reserve Bank of India's management of foreign exchange reserves has received plaudits from many observers, including the IMF. The central bank has, however, erred on the side of caution. "Better safe than sorry" seems to be its guiding mantra. I have observed earlier in these columns, in my review of the RBI's Annual Reports, that the returns the central bank gets on its reserves are low in comparison to those obtained by such countries as Singapore.

The accounts for 2004-05 published in the RBI Annual Report show that the rate of return on foreign exchange assets earned in 2004-05 stood at 3.2 per cent before accounting for depreciation on securities. After depreciation, the report says, the return in 2004-05 was 3.1 per cent. Thus, on foreign currency assets amounting to Rs 5.75 lakh crore of rupees, the RBI earned the rupee equivalent of roughly Rs 17,000 crore.

Let us compare this with what the Singapore Government earns on its investments of foreign exchange reserves, which also amounted to $128 billion in May. The Government Investment Corporation (GIC) of Singapore, which manages these investments, recently declared its results. Its Chairman, the venerable Mr Lee Kuan Yew, its former Prime Minister and current Senior Minister, pointed out that in each of the 25 years since its inception, it has earned a return of 9.5 per cent a year, in US dollar terms. Compare this with the 3.1 per cent our reserves have earned!

Just imagine if the RBI had followed the island-state's example, our national economy would have earned a whopping six percentage more a year. In one year alone, it would have earned Rs 30,000 crore more, which would have helped amply finance many of Mr P. Chidambaram's schemes. All that it needs is more imaginative and, at the same time, careful investment of at least a substantial part of the foreign currency assets through an investment vehicle on the lines of GIC.

Singapore example

As Mr Lee, who has been Chairman of GIC from its inception, observes in his statement, Singapore's example has been infectious. China and South Korea have, he says, already copied its modus operandi. The important point is that GIC invests the currency reserves in the equity and bond markets of the developed and developing world instead of restricting their deployment to US government securities.

GIC, Singapore, also has a real estate investment arm which holds valuable real estate investments in the developed world. The investment is also partly co-managed by leading investment bank Goldman Sachs.

What does it take for India to follow the Singapore model? Obviously, it requires a change in mindset. Safety is, after all, the watchword of central bankers. But, at the same time, the responsibility to secure a decent and safe return cannot be abjured. The RBI has definitely seen light at the end of the tunnel, as is seen from one of Governor Reddy's recent statements in New York, published in the RBI Bulletin.

Referring to the management of forex reserves, Dr Reddy pointed out that as the reserve level rises, it is possible to diversify the portfolios and, increasingly, there can be an emphasis on returns at the margin. He makes the point that when the level of reserves exceeds that of foreign liabilities, they become a part of national wealth and not "reserves" as such. (I presume Dr Reddy is referring to external debt mainly and not to the accumulated liabilities represented by FII and FDI investments.) "In such a case", he says, you can create a separate corporation, as Singapore has done, and do the wealth management.

But we have not reached the stage where our external assets are far higher than external liabilities to be able to treat it as purely a wealth management issue. We are in the intermediate stage. I do not quite agree with the Governor's views that we are far from the stage where the wealth has to be managed as such. The external debt to reserve ratio is around 1.

In fact, I would argue that when the assets are less than liabilities, we have to be even more careful about the returns being adequate because as returns become less, the liabilities had to increase.

There is obviously a change of mindset and I hope impediments are not put in the way of the RBI's promised innovation in forex reserves management.

Change governance style

In attempting to follow Singapore example, we should not merely stop at creating a GIC, India. It is the whole style of governance, of incentives and human relations that determines the high quality of the GIC's returns. The body is singularly free of any government interference. No question of directed investments in specific shares. The Government of India too has to learn to abide by a policy of non-intervention with the new public sector enterprise, which, in a sense, should enjoy the autonomy inherent in a central bank entity.

I can hear critics observe that this is all a pipedream. We have no tradition of letting public sector entities act autonomously. Obviously, this has not been true of the revitalised UTI, which has achieved significantly robust returns as a mutual fund. So has SBI Mutual Fund. Given the political will and compulsions to achieving good returns with safety, the proposed Government Investment Corporation of India will also do a good job.

Mr Lee was particularly emphatic that the GIC of Singapore under his stewardship had achieved returns of 9 per cent, i.e. 5 per cent above the global inflation rate. He was particular about the care taken to ensure that Singapore's savings did not suffer any erosion in value. GIC, Singapore, does offer a useful model that India can adopt with suitable modifications.

Safeguards

It is obvious that what operates in Singapore may not translate too smoothly in India. It behoves Dr Y.V. Reddy to consult his experts, both within and outside the RBI, about the safeguards he would like to impose on such investments. Only, he should take care that it is not too many safeguards and no accelerator.

Whether the RBI will try to follow the aggressive model adopted by Singapore in respect of investments in real estate and hedge funds is a matter worth further exploration.

Dr Reddy will, of course, tread carefully lest the nest-egg be busted. There are risks in deploying funds in real estate. There may be no buyers for the distressed real estate assets. Limits will, no doubt, be laid on such deployment.

Governor Reddy's statement in New York shows he is willing to initiate change. He has rightly put limits on himself. It is reasonable to expect that he will carry out his investment function with due care to safety and returns — in the same way as he is discharging his overall responsibilities. The Singapore way is the way to go, provided we learn to do it in the style that the Singapore GIC functions.