It's better to be safe even if it comes at the cost of lower returns. This seems to have been the guiding philosophy of India when it came to deploying forex reserves.

In recent years, deployment of forex reserves has clearly shifted away from return and liquidity, towards safety. The move to increasingly deploy forex reserves in “safe” securities had accelerated especially in the aftermath of the financial crisis that struck the developed world post September 2008.

Safety, liquidity and yield on reserves have been the principal objectives of India's reserve management. Forex reserves include three items — gold, special drawing rights (SDR) and foreign currency assets (FCA).

India's FCA are deployed in securities; as deposits with central banks, the Bank for International Settlements (BIS) and the International Monetary Fund (IMF). FCA are also deployed as deposits with foreign commercial banks and as funds placed with external asset managers (EAM).

For the period ended September 2010, the percentage share of FCA held in securities rose to 55.2 per cent, more than double the 21.6 per cent in September 2006. On the other hand, the amount invested with external asset managers (EAM) has fallen to 2 per cent from 30.2 per cent over the same period.

While returns are lower, India's increasing dependence on volatile portfolio flows to finance the current account deficit suggests that such a focus on safety is a prudent approach, Ms Sonal Varma, India Economist, Nomura Financial Advisory, said in a research note.

In the interest of safety of funds, the placement of reserves with external asset managers has been considerably brought down, especially after the international financial crisis.

The drop (in percentage terms) was also heightened by the surge in forex reserves from a level of $160 billion-plus in mid-2006 to a level of about $285 billion in mid September 2010.

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