What made India the biggest buyer of US treasury securities in Apr-July

With the Federal Reserve on a dollar printing spree to save the American economy from a deeper pandemic hit, the supply of US treasury securities has increased dramatically since March. The RBI has been an avid buyer of these securities, despite the risk of capital loss and low interest rate on these instruments.

A Fed release shows that the aggregate foreign holding of US treasury securities held by all countries increased just 1.6 per cent in four months — from $6.9 trillion towards the end of March to $7.08 trillion towards the end of July. This shows that most countries have been wary of increasing dollar exposure in this period.

But, at 24.3 per cent, India registered the highest increase in US treasury holdings in this period, from $156.5 billion in March to $194.6 billion in July. Next came Ireland, with a 21.8 per cent increase. A few other countries, such as Kuwait, Poland, Israel and Mexico, have also recorded significant increases in their holdings.

Among the countries that have reduced their exposure to US dollar denominated securities, Saudi Arabia is the most prominent, reducing its assets by 21.7 per cent. European countries such as Norway, France, Italy and the UK have also reduced their respective holdings.

The background

With the Fed’s borrowing programme expanding dramatically, its holdings of treasury and agency mortgage-backed securities increased $2.36 trillion from mid-March to mid-August 2020. But, as the above numbers show, most of these securities seem to have been purchased by US-based institutions.

There are two key reasons why most countries have avoided additional exposure to dollar-backed securities. One, the dollar has turned quite weak with the unlimited note printing by the Fed. The dollar index that tracks the movement of the greenback against a basket of currencies declined from 102 in March to 92 in August-end, losing 10 per cent. The prospect of capital loss in the value of their holdings would have kept most global central banks away.

Two, with the Fed slashing fund rates to almost zero, the interest revenue from these holdings has also whittled down significantly.

Problem of plenty

So why is the RBI buying dollars?

It has been a problem of plenty for the RBI as far as the external account goes. There have been multiple factors acting to keep the rupee strong since March — weakening dollar, fall in crude oil prices, foreign portfolio inflows in equity market and external commercial borrowings of Indian companies. The RBI has been trying to keep the rupee from appreciating too much, by buying dollars. This is reflected in the foreign exchange reserves surging to $542 billion.

It needs to be noted that despite the RBI’s intervention, the rupee has strengthened from over 77 against the USD in March to 73 now, registering a gain of around 5 per cent.

A look at the composition of the RBI’s forex reserves shows that 92 per cent of it is held as foreign currency assets. These assets have increased by $101 billion over the past year.

This increase in dollar holding will prove detrimental if the greenback depreciates further. The RBI’s revaluation reserves will have to be marked lower in that case. Also, the interest earned from securities backing forex reserves will decline if the RBI keeps hiking its exposure to dollar-backed securities.

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