Foreign Exchange Reserve Management

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					Foreign Exchange Reserve
Highest 10 FX Reserve Holder
  Rank             Country           billion USD (end of month)
   1     Peoples Republic of China   $ 2273 (Sep 2009)

   2     Japan                       $ 1019 (Jun 2009)

         European Union              $ 716 (Oct 2009)

   3     Russia                      $ 448 (Dec 2009)

   4     Republic of China           $ 348.2 (Dec 2009)

   5     India                       $ 287.37 (Dec 2009)

   6     South Korea                 $ 270.9 (Nov 2009)

   7     Hong Kong                   $ 240 (Nov 2009)

   8     Brazil                      $ 239.7 (Jan 2010)

   9     Germany                     $ 184 (Sep 2009)

   10    Singapore                   $ 182 (Sep 2009)
 To analyze the various sources of Forex income of
    Bangladesh Bank.
   To Identify whether BB is utilizing/investing Forex reserve
    of Bangladesh efficiently
   To find out the exchange rate volatility effect on our FX
   To identify different promising sectors for FX investment in
   To compare the FX investment of Bangladesh with that of
    China and India and other portfolio FX investment income
    of Bangladesh.
   To suggest pragmatic recommendations for increasing
    Forex reserve.
Factors of FX Reserve
 Wage Earners’ Remittance
 Exports’ Receives
 Governments Loans & Grants
 Investment’s Income from Forex Reserve
 Foreign Direct Investment
 Other Factor like Exchange Rate
Factors of FX Reserves Cont…
Wage Earners Remittance
 WER is the main sources of forex reserve in the FY 2008-
  2009 the total WER was US$ 9,689.26 m but in our country
  the labor force are neglected though it is the highest
  contribution in official reserve.
 If we consider our FX investment income meets the
  expenses (Official and others) without hampering WER
  then the official reserve should be US$19.35 billion by
  November-2009. It also be noted that here I do not
  consider government loans and grants of foreign donor.
  But here the government payment and trade deficit mainly
  pull back the FX reserve to this horizon point in
  November-2009 and that is US$ 10.34 billion.
Factors of FX Reserve Cont…
Export Received                    Foreign Aid
 Total export receipts of          Bangladesh got total US$
  Bangladesh (including              28,193.75 million foreign loan
  exports of EPZ) during the         since independence from
  years, 2008-2009 and 2007-         development partners.
  2008 amounted to Tk. 97498.1
  crore and Tk. 87022.2 crore or
  US$ 14170.7 million and US$
  12685.4 million respectively.
Factors of FX Reserve Cont…
Foreign Direct Investment
 Calculation of FDI not Accurately Possible
It can be cleared by two illustrations
Retained Earnings is a part of Owners Equity. We show initial
   Investment by a Foreign National or Organization as FDI but
   when they repatriate their equity portion to native country by
   liquidation or by selling to others, they claim a portion from
   their Reserve account.
Another example is that when a foreigner invests in capital market
   as portfolio investment, we cannot say the investment amount at
   any particular time without account for. Like if someone invests
   $10,000 in December 01 and with his profit it may stand $13,000
   in December 31. Now the question will arise that what is the real
   amount of his Portfolio Investment or what the amount was in
   December 15.
Factors of FX Reserve Cont…
Exchange Rate
 Factors that influence Exchange Rate Movements are:
    Demand for Foreign Currency in case of if Import increase
    Supply of Foreign Currency in case of if Export increase
    Relative inflation Rate
    Relative Interest Rate
    Relative Income Level
 To maintain the same exchange rate if there is increased
  demand, the central bank can issue more of the domestic
  currency and purchase the foreign currency, which will increase
  the sum of foreign reserves. In this case, the currency's value is
  being held down; since the domestic money supply is increasing,
  this may provoke domestic inflation. In practice, some central
  banks, through open market operations aimed at preventing
  their currency from appreciating, can at the same time build
  substantial reserves.
Investment’s Income on FX Reserve
 Income in Current Account from 01-07-2009 to 31-12-
  2009 was only Taka 150,244,638.68
 Income in STD from 01-07-2009 to 31-12-2009 was only
  Taka 576,814,710.68
 Income in T-Bills from 01-07-2009 to 31-12-2009 was
  only Taka 252,022,663.41
 Income in Bond from 01-07-2009 to 31-12-2009 was
  only Taka 311,289,951.54
Country Experience - China
 Reserves Dynamics for the Current Account with
 Government Stakeholder
Country Experience – China Cont…
 Decomposition of Cumulative BOP
 Country Experience – China Cont…
                     Treatment of the Claims on Reserves

                               Transitory Capital Account       Private Sector Trade Balance
Present Value of Claim         20% of Capital Account           80% of Current Account
Nature of Claim                Transitory Capital Inflows       Deferral of economic
                                                                consumption through a bong
                                                                sterilization program
Reserve Management Principle Liquidity: ensure future capital   Liability Match: ensure future
                             outflows can be repaid from        sterilization bond value is
                             future foreign reserves            matched by future foreign
Reserve Allocation             Future value of allocated        Future value of allocated
Computation                    reserve = expected value of      reserve = future value of
                               future cash outflows             sterilization bonds
Country Experience – China Cont…
 Transitory Capital Account: Future Claims on
 Forex Reserve
Country Experience – India Cont…
 India’s approach to reserve management until the BOP crisis of
  1991 was essentially based on the traditional approach i.e. to
  maintain an appropriate level of import cover defined in terms of
  number of months of import equivalent to reserves. Against the
  backdrop of currency crises in East Asian countries in 1997 and
  in light of country experiences of volatile cross border capital
  flows, it was felt that there was need to take into consideration a
  host of factors, including the shift in the patterns of leads and
  lags in payments/receipts during exchange market uncertainties.
  Thus unencumbered reserves assets were required to available at
  any point of time to the authorities to fulfilling various objectives
  assigned to reserves. It would also be noted that in that period
  RBI have to pay a big amount to multinational and Foreign
  Portfolio Company or investors by liquated their gold and
Country Experience – India Cont…
 Indicators                          India                                       Bangladesh

Trade based   import cover 11.5 month end of March 2002               Our OR could cover 9.46 months
                                                                      trade deficit and 2.98 months
                                                                      Import payment at the end of
Money         The proportion of NFA of RBI to currency with the       The proportion of FX reserve of BB
based         public sharply increased from 15% in 1991 to 109% as    984.26%      of     Wage   earners
              of end of March 2002 and NFA to M3 increase more        remittance at end-November, 2009.
              than 6 fold from 3% to 18% during the same period.      Also FX reserve is 196.75% of M1
                                                                      (Currency in Circulation)
Debt based    FX reserve substantially decline from 147% as of end-   Trade deficit 0.72% of OR at end
              March 1991to 8% as of end-March 2001 and                February, 2009 but the external
              sustainable external short term debt component          debt was 270.79% of OR at the end
              decreased from 10% as of end March 1991 to 3% as        December, 2009.
              of end-March 2001.
Analysis –STD & Bond (Inv)
 Investment in USD is 8.12% of OR and average rate of return
    0.20% and decreasing trends
   Investment in GBP is 7.42% of OR and average rate of return
    0.50% and increasing trends
   Investment in EUR is 2.54% of OR and average rate of return
    0.38% and stable trends
   Investment in AUD is 2.41% of OR and average rate of return
    3.90% and increasing trends
   Investment in CAD is 0.05% of OR and average rate of return
    0.40% and stable trends
   Investment in USD bond is 1.94% of OR and average rate of
    return 5.55%
   Investment in AUD is 0.91% of OR and average rate of return
Reason for Decreased of income

 World’s Economic recession
 CA rate falls and reserve shift to CA for security purposes
 STD rate falls as LIBOR falls below CA rate and investment
  withdrawal from STD and shift to CA
 Floating rate falls and long term bond investment incur
 Fixed rate coupon bond increased but it was the negligible
  portion of OR only 0.8% of OR up to May-2009.Gold
  bullion rate is increased but it was negligible portion of
  reserve only 0.48% of OR.
 TB rate has the negative effect and premature TB incur loss
  has to sell less purchase cost.
Currency in Circulation
 Our total currency in circulation is 36,000 crore Taka
  where forex reserves is backed for an amount of 22,000
  crore taka i.e. 61.11% currency in circulation backed by
  FX reserve and every year the circulation increased by
  about 15%. So adequate reserve is needed to fulfill the
 V = (P x Y)/M, where V is the velocity, P is the price
  level, Y is the real GDP and M is the quantity of money
V = (2.06*81,938)/42,337.14 = 3.99 ≈ 4
Conclusion & Recommendations
 By the mid 2009, When long term fixed rate was
  higher and attractive enough to invest in fixed rate but
  then we invested in floating rate instead of having
  smart reserve that was not profitable for investment
 Only investment committee decided the investment
  portfolio and no proper portfolio investment takes into
  account rather only bench mark as per currency
  denomination, most investment takes place as short
  term basis. Now IC decided to invest in portfolio invest
  with BIS who has eligible portfolio officers as profit
  sharing basis.
Conclusion & Recom contd…
 BB is yet to move into derivative markets although these markets are highly profitable for
  forex investor But BB practice in low margin risk so it need to calculate meticulously the
  risk or must have the back up of return of funding
 BB can make loan through AD for them, who are eligible to take loan from IFC, IDB etc.
  BB can use transitory capital account by sell in credit through AD for future claim in
  forex reserve from which promising exporter can get fund
 Investment in FC less than inflation rate makes itself local currency depreciated against
  foreign currency. Our actual inflation is two digits and what we showed (around 6%) is
  also much greater than our today’s investment which is around (1%) and forex
  investment is 6 times lower than inflation rate.
 CA rate falls and reserve shift to CA for security purposes. Also STD rate falls as LIBOR
  falls below CA rate and investment withdrawal from STD and shift to CA
 Floating rate falls and long term bond investment incur loss and Fixed rate coupon bond
  increased but it was the negligible portion of OR only 2.85% of OR as end of December-
 TB rate has the negative effect and premature TB incur loss has to sell less purchase cost.
 Our OR is US$ 10.34 billion at the end of December-2009. If we manage our all expenses
  like official payment & import payment from investment income of forex reserve, the OR
  will be stood in US$ 19.35 billion i.e. just double of existing.
Conclusion & Recom contd…
 Export/Import must be expedited by
    Special priority sector like Finished Leather, Frozen Food, Handicraft, Electrical goods,
       Fresh Flower, Jute goods, Herbal medicine etc.
      Providing facilities like, concessional interest rate, income tax exemption, financing
       against soft terms and conditions, reduced transport cost, duty draw back or bonded
       warehouse facility, infrastructural and supporting industry development, discover new
       market etc.
      Highest priority sector like, Software and ICT products, Agro products and processing,
       Light Engineering, Shoes and Leather products, Pharmaceuticals products, Textiles etc.
      Encouraging of labor intensive export commodities and developing skilled manpower for
       international trade by imparting suitable training
      Adaptation of New strategy for expansion of export market maximum utilization of
       computer technologies and giving support to existing exporter also promoting new
      Not need to expedited export by devaluing or depreciate our own currency, this will
       promote export a short time but the effect is bad in the long run as we the country of
       import oriented so it increase the value of import commodities, so, we have to pay more
       and there is chance to inflation for the export oriented products. So the both way negative
       impact make the local currency horrible deflation and the best way to make currency
       stable against hot currency.
 Conclusion & Recom contd…
      We know if WMP > DMP a country will export and if WMP < DMP a country will
      import and for both way there is a domestic gain i.e. trade is a gain of both way win-
      win game
            a.Domestic producers are better off incase of exports
            b.Domestic consumer are better off incase of import

Figure11: Win-win Game

                                                                                 Before export PS = POMDMP
                                                                                 after export PS = PORWMP
                                                                                 Before Import CS = DMDMP and
                                                                                 after import CS = PORD
Conclusion & Recom contd…
 Our currency is partially convertible i.e. our current
  account is convertible but capital account is not. Our govt.
  not allowed bearing money with personal interest or to
  trade with different country in foreign region. Much reason
  behind this one of them may be syndication but as soon as
  we can convertible our currency that may help to grow our
  economy better and with fearless flying. Some
  precondition can be given for convertibility of taka
    Appropriate exchange rate is fairly important and with realistic
    Reasonable reserve required to face the cyclical shortfall of BOP
    Domestic producers should be well equipped to harness the benefit
     of the open economy
 Conclusion & Recom contd…
  Benchmark   Defined   Actual

  USD         60%       68.22%

  EUR         20%       14.93%

  GBP         10%       11.50%

  AUD         6%        4.09%

  CAD         4%        1.25%

In my paper I discussed earlier the most profitable is bond, USD bond’s average return 5.55%
and AUD bond’s average return 6.16%. The Return of AUD in short term is most profitable. So
IC committee can increase the benchmark for AUD say,10% of benchmark. Also BB can invest
more in conservative approach i.e. in long term financing, as well as it seeks for maturity
matching approach, payment should make through long term maturity. But BB used to invest
aggressive approach where there is uncertainty of future investment rate. There is a vast
investment in US T-Bills and current account which returns is near zero. So IC committee must
decide to transfer the FX investments’ short term USD portions (T-Bills) in long term (USD or
AUD bond) or profitable short term (AUD) based investment.

Description: Presentation on Foreign Exchange Reserve Management. Focusing on Developing countries like Bangladesh, India, China etc.