The crux of the matter is that the RBI, like many other central banks, has been investing the bulk of the reserves in safe and liquid instruments such as U.S. government treasury bills. However, these yield very little by way of return. Critics and their number is rising in tandem with the reserves say that the central bank should consider investing a portion of the reserves in higher yielding assets.

High up in the list of eligible avenues is the launch of a sovereign wealth fund (SWF), which will manage a portion of the reserves and act as a kind of portfolio manager. Many countries have such funds. The oil rich West Asian countries have used this route to invest their petro dollars. Some funds such as Abu Dhabis are huge. Saudi Arabia launched one recently. Outside the oil exporting countries, the experiences of Singapore and China with their sovereign wealth funds, are seen to be more relevant under Indias circumstances.

But are they? Indias forex reserves are certainly large but are miniscule in relation to Chinas. Even Singapore, which has a tradition of managing its forex reserves, has a sizable corpus invested through its government-owned funds. More importantly, there is a big difference in the way these countries have accumulated their reserves.

Chinas extraordinary trade surplus is well known while Singapore earned its dollars both through trade and services. India, in contrast, accumulates dollars essentially through a defensive central bank action to prevent undue rupee appreciation. Foreign portfolio flows into the stock markets are the single largest component of capital inflows. During the fist nine months of 2007-08, portfolio inflows were of the order of $33 billion out of total net inflows of $83.2 billion. The other important contributors were external commercial borrowings ($16.3 billion) and short-term credits ($10.8 billion).

Up to a point these flows have their uses. Indias merchandise trade deficit has been widening. From a level of $59.3 billion in 2006-07, it has widened by 35 per cent to touch $80.4 billion in 2007-08. Imports of petroleum and non-petroleum products have been increasing. While earnings from invisibles earnings from software and other services exports and workers remittances from abroad have helped in bridging the trade deficit, capital inflows have propped up the countrys balance of payments.

Since the foreign balances have become embarrassingly large, the RBI has had to intervene by first buying the surplus dollars and then sterilising the rupee releases (to avoid excess liquidity in the domestic market). This is a significant aspect of Indias exchange rate management.

However, while deploying the accumulated forex reserves, it is important to keep in mind that the capital inflows under all categories will not be stable. The RBI has been categorising them in terms of their liquidity. These capital flows can reverse their direction any time. Short-term borrowings and external commercial borrowings cannot also be relied upon to stay the course. In fact, several policy initiatives to check such inflows have been in place.

So, one cannot obviously commit reserves that may not be of a long-term nature. The earlier suggestion to earmark a portion of reserves for infrastructure first mooted by a committee headed by Deepak Parekh was controversial in that it did not take into account the RBIs legitimate concerns over such deployment. Yet, it has been implemented with the caveat that the reserves will be utilised outside India for meeting genuine forex requirements of eligible infrastructure developers in India.

There are doubts as to whether the scheme will succeed. For, there is no shortage of resources, either domestic or foreign, to fund infrastructure. In fact, the RBIs accumulation of reserves is an indication that forex is available and not being utilised. But the availability of these resources for all time to come cannot be taken for granted.

Hence, investing a sizable portion of reserves through a sovereign wealth fund cannot be a sensible option at this stage. There are other objections too to such a move.

(1) Deploying even a small portion of the reserves in domestic assets is not an option. Most of the accumulations to reserves have arisen out of RBIs action in mopping up dollars. Hence rupee funds have already been released.

(2) It is not as though the management of reserves is a losing proposition. There are important benefits. Indias standing goes up. Besides, from a foreign perspective, reserves are viewed as an insurance and one cannot quantify this advantage in monetary terms alone.

(3) Unless the sovereign wealth funds are properly managed, there would be complaints of nepotism, corruption, not to speak of underperformance. It is highly unlikely that the Government of the day will induct professional fund managers from outside while the government as fund manager may not be equal to the tasks.

C. R. L. NARASIMHAN