India's central bank weighs investment options
AsianInvestor recently visited India’s central bank in Mumbai to discuss the markets, its interest in expanding into non-G7 sovereign debt and even into investment-grade global bonds.
The Reserve Bank of India (RBI), which had $353.6 billion in reserves as of July 24, requested that AsianInvestor did not quote it directly. However, we are allowed to give a flavour of the conversation as an indication of the bank’s collective thinking.
The RBI has three primary objectives as far as management of reserves is concerned. In order of importance, they are: preservation of capital; maintaining liquidity to overcome any balance of payment issues; and profitability.
The bank follows an active management strategy, investing in sovereign fixed income securities, as well as certain supranationals and gold. Investment guidelines limit the bank to investing in AA-rated countries or above, chiefly G7 advanced economies. Duration must be below 10 years.
Until recently the RBI outsourced management of less than 5% of reserves to external fund houses, giving them a three-to-four month leeway in terms of duration. But due to disappointment with their performance against the JP Morgan Global Aggregate Bond Index, within the past nine months RBI has moved to insource all external mandates.
Yet the bank has become increasingly concerned with low government bond yields. Whereas in past years it was able to rely on a 5-5.5% return, that has since shrunk to close to 1%.
The bank is sensitive to the impact that quantitative easing (QE) programmes in the US and Europe have had on its economy and its reserves. Because of strong resulting inflows into emerging markets such as India, the central bank has had to manage its monetary policy actively, putting its operations under tight constraints.
Certainly it would like to see a coordinated withdrawal of QE when it happens and it considers lack of coordination among monetary authorities worldwide as a chief concern.
Low bond yields have encouraged the RBI to look beyond G7 countries. The sovereign rating downgrade of the US shocked the central bank and acted as something of a trigger.
Within Asia, the RBI looks at the sovereign debt of Korea and it has always invested to some extent in Japan, although there is a feeling that the turnaround of the Japanese economy under Shinzo Abe is happening more slowly than was anticipated.
It is also looking at China, although its challenge is choosing an entry point given slowing GDP growth and continued renminbi depreciation. Such matters are discussed regularly, both within the RBI and with the government.
Eventually there is the prospect that the RBI will move down the credit curve into certain investment-grade corporates. It does see value in that, although this is not part of its mandate right now. It would consider outsourcing again to external asset managers if the case was strong.
Lack of liquidity in secondary bond markets is something the RBI says it is aware of, noting it is absorbing, processing and analysing market information on this. But as of now it is not a concern owing to its restricted mandate.
As for discussions on the creation of an Indian sovereign wealth fund to manage part of its foreign exchange reserves, these are rendered redundant by the fact that India has a current account deficit. While the recent drop in oil prices helped to improve the country’s external debt position, a surplus (and therefore a sovereign wealth fund) remains some way off.