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Mumbai , Aug. 27

A SUFFICIENTLY high level of foreign exchange reserves is necessary, states the Reserve Bank of India in its Annual Report 2002-03, to ensure that even in case of prolonged uncertainty, reserves can cover the `liquidity at risk' on all accounts over a fairly long period.

According to RBI, "The quantum of reserves in the long-run should be in line with the growth in the economy and the size of risk-adjusted capital flows, which provides greater security against unfavourable or unanticipated developments, which can occur quite suddenly.''

The report throws some light on the maturity of the investments made of the country's forex reserves. There are two broad portfolios with independent risk parameters namely, the money market portfolio with lower risk and maturity below one year and the bonds portfolio of longer duration. With regards to risk management of the forex kitty, the report stated that the overall approach to reserve deployment was one of high risk aversion with a preference for stable returns.

Credit risk arising out of potential default or delay in payment of obligations is taken care of by investing selectively only in financial instruments issued by sovereigns and `AAA' rated banks and supra-nationals.

Deposits with commercial banks and transactions in foreign exchange/bonds/treasury bills with commercial banks/security firms are subjected to stringent criteria for selection of approved counter-parties; limits are also fixed for each category.

The day-to-day developments in respect of the counter-parties are closely monitored, if necessary credit limits are pruned down or delisted altogether.

The foreign currency reserves are invested in multi-currency multi-market portfolios depending on the likely currency movements and other medium term considerations.

However, the exact break-up of this is not released by the RBI since it is considered to be market-sensitive information.

The interest rate sensitivity of the reserves portfolio is identified in terms of benchmark duration and the permitted deviation around the benchmark, which is specified for each portfolio, based on the risk tolerance levels set by RBI.

As far as liquidity is concerned, exercises were being undertaken to test the liquidity at risk of the various constituents of the reserves, said the report.

Within the apex bank, there is a total separation of the front office and back office functions and the internal control systems ensure several checks at the stages of deal capture, deal processing and settlement.

A major portion of the securities are custodised with the central banks of the US, UK and Japan. All primary cash accounts are with foreign central banks. The Bank for International Settlements provides both custodial and investment services for investments placed with it. A small portion of other securities and assets are managed by external asset managers, custodised with carefully selected global custodians.

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Risk aversion, stable returns guide forex kitty investments

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