Emerging Economies Should Diversify Their Forex Reserves Out Of US Dollars, Says Indian Economist

“The payment settlement method should not be confined to a small number of people and emerging economies should diversify their forex reserves out of US dollars,” says an Indian economist who has been watching the developing situation around the globe with a keen eye.

Emerging Economies Should Diversify Their Forex Reserves Out Of US Dollars, Says Indian Economist

In reaction to Moscow’s special military operation in Ukraine at the request of the republics of the Donbass region, the United States and its allies have announced “economic war” on Russia, seeking to break off the $1.7 trillion economy from the global financial system.

In addition to sanctioning political leaders, businesses, and banks, the West has frozen $630 billion in Russian forex reserves kept in various parts of the world. Russia is one of the world’s largest suppliers of oil, gas, and metals.

Previously, the US imposed identical limits on Afghanistan’s, Iran’s, Cuba’s, Iran’s, and Venezuela’s forex reserves, clearly suggesting that the US has a stronghold over allowing access to dollar reserves, confirming that politics frequently play a role in the issue.

Journalists spoke with Professor NR Bhanumurthy, economist and vice-chancellor at Bengaluru’s Dr BR Ambedkar School of Economics University in the Indian state of Karnataka, regarding the United States’ moves against Russia.

Interviewer: The recent move by the United States to withdraw its holdings of Afghan and Russian forex reserves has alarmed several Indian intellectuals, who argue that India’s foreign exchange reserves should be methodically diversified. What are your thoughts on the US decision, and should India’s central bank, the RBI, diversify its reserves?
 
Dr. NR Bhanumurthy: Whether it is individual or public wealth, diversifying financial assets is critical to mitigating unanticipated risks. Recent incidents in Afghanistan and Russia serve as more evidence that it is essential for all emerging market economies, not just India, to diversify their forex reserves.

The Reserve Bank of India does diversify and it is not necessarily the case that all of India’s reserves are invested in the US … indeed we also have a significant component of gold reserves, and currency assets other than the US dollar.

However, there are constraints to the level of diversification because a major portion of trade, both in current and capital accounts, is conducted in US dollars.

Interviewer: According to the most recent RBI statistics, the country’s gold reserves are worth $42.5 billion, or about 7% of overall forex holdings. Should the Reserve Bank of India boost its gold reserves? How does this benefit India?

Dr. NR Bhanumurthy: The size of a country’s gold reserves is governed by both strategic and domestic demand. Variations in the size of such reserves are determined by the riskiness of other portfolios, in this case foreign currency.

The RBI should be in a better position to decide on how big its gold reserves are. Ultimately it is important to see that the Indian rupee becomes a reserve currency like the US dollar, euro, etc.

Interviewer: Although the absolute value of gold reserves has increased in recent years, the returns on the RBI’s forex currency holdings have been terrible due to low interest rates in the West. What possibilities does the RBI have for increasing value?

Dr. NR Bhanumurthy: The goal of forex reserves is not always to earn interest; it has a variety of goals. On the other hand, while nominal interest rates in India are higher, real interest rates do not differ significantly between the currencies in the long run.

Interviewer: There is a scary possibility currently in which the dollar rises to a record high against the Indian rupee – or other currencies – amidst the US current account deficit widening. This might have a significant impact on India’s import bill. Can India get into currency exchange arrangements with Middle Eastern countries in order to cut the cost of oil imports?

NR Bhanumurthy, MD: We’ve been talking about currency swaps for a long time, but there are a few inherent concerns involved. They are regulated by individual governments or central banks rather than market forces.

The India-Iran talks are still ongoing, and I am hopeful that new solutions will emerge.

Interviewer: According to a study by an Indian parliamentary committee, the government should investigate alternatives to the SWIFT payment system. What are your thoughts on this concept?

Dr. NR Bhanumurthy: The payment settlement method should not be confined to a small number of people. India has already successfully established the RuPay card, a global card payment system equivalent to Visa and Mastercard. Any alternative solutions that lower transaction costs must be investigated.

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