ReserveaccumulationandmusclememoryofAsiancrisis

As per the Weekly Statistical Supplement published by RBI every Friday the total reserves within the RBI stand at USD 534.5 billion as of the week ending July 31^st 2020. Out of the total reserves of USD 534.5 billion, USD 490.8 billion is contributed by foreign currency assets (basically RBI holding of assets denominated in currencies like USD and Euro, US treasuries take the lion’s share of the holding) and USD 37.62 billion in gold holdings. The rest is formed by SDR and IMF reserves. For the week, the increase in foreign currency assets is USD 10.3 billion and the gold holding has increased by USD 1.5 billion. In case we take a simple view and discount the Euro upward revaluation, the stats tell us that RBI made USD 10 billion worth of fresh currency purchases, a significant amount! Only four countries are ahead of India in terms of total reserves - China, Japan, Switzerland and Russia.

In the book The Dollar Trap, IMF economist Eshwar Prasad spends considerable time detailing the impact of reserve accumulation by the emerging market economies. First of all, the increase in reserve results in halting the local currency appreciation which aids the local exporter at the expense of importer. The export assistance helps in aiding local jobs. The causality though, is not so simple, because many manufacturing supply chains have requirements for intermediate imported goods hence the currency depreciation has an adverse impact on them.

As per Mr Prasad, the primary objective of reserve accumulation by EMEs is insurance against a crisis. He writes that any currency crisis is essentially pro cyclical in nature. Signs of trouble in the economy feed the suspicions of foreign investors who would then demand their loans to be repaid immediately, fuelling a downward spiral. This is what happened during the Asian crisis of 1998 when the foreign currency debt and pegged local currencies created a heady cocktail of everyone running to the door all at once. The author writes that this incident created a sort of muscle memory response in central banks in these economies, prompting them to keep on adding to reserves. Our readers would easily recognize which country/currency is the unintended beneficiary of such a response system.

In other news, the talk of the federal government stimulus is gaining ground again. President Trump tweeted that his executive diktat last Saturday has resulted in Democrats finally agreeing on a deal. This will be supportive of risk assets. On the other hand there are further measures announced by the US Treasury Secretary targeting China which will increase the Sino US rift, which will be negative for risk. The Dow Jones ended 1.3% up in yesterday trading.

Domestically, Indian bond yields have been going up since the policy announcement last week. The lack of any announcement on the OMO side coupled with the fear of increase in bond supplies have hurt the yields. The GS 5.79 2030 currently trades at 5.89.