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Monday, Nov 14, 2005


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Rising US interest rates — Dollar-denominated securities' holdings see steep fall

C. Shivkumar

Holders of US treasuries would incur losses if they are liquidated at current market prices.

Bangalore , Nov. 13

FACED with increasing US interest rates, India's holdings of dollar-denominated securities are witnessing sharp depreciation.

India holds at least $17.6 billion worth of US dollar-denominated securities of its $144-billion foreign exchange reserve. Most of the securities holdings are in the form of US treasuries.

The sources said with the 12 consecutive increases in US interest rates, treasury yields have risen commensurately. This implied that the current market prices of its securities are lower than the acquisition prices. This meant that holders of US treasuries would incur losses if they are liquidated at current market prices.

Besides, the Reserve Bank of India (RBI), financial institutions such as the General Insurance Corporation of India and foreign branches/subsidiaries of Indian banks also have substantial investments in US dollar-denominated securities.

In fact, the RBI, in its internal report on foreign exchange reserves in August, admitted to a drop in returns due to depreciation. The report said, "During 2003-04 (July - June), the return on foreign currency assets and gold after accounting for depreciation decreased to 2.1 per cent from 3.1 per cent during 2002-03, mainly because of lower money market interest rates in major countries and a fall in securities prices during rise in longer-term yields."

This year, the drop in returns is likely to be far steeper, bankers said, in view of the rise in the repeated hikes in the Federal Discount rates. The Federal discount rate or the Fed rate is currently 5 per cent, up from 3 per cent over the corresponding period of the previous year. The two per cent increase in interest rates has impacted secondary market yields. Yields on five-year treasuries are currently at 4.55 per cent, one per cent more than what they were a year ago. In the case of two-year securities, the yields are at least 175 basis points higher.

Unlike China or Japan, India's investments in US government securities are at the shorter ends for reasons of liquidity.

Moreover, banking sources said that Indian institutions and the RBI have been moving out of the US treasury securities holding more in the form of deposits with other central banks, the Bank for International Settlements, multi-currency deposits with commercial banks to offset the impact of depreciation on the investment earnings.

Bankers said that it was the shrinking returns on investments that prompted restrained intervention by the RBI in the foreign exchange markets.

In fact, bankers said, the most effective tool for managing excess liquidity is through restrained intervention in the foreign exchange markets when the rupee depreciated.

The restrained intervention had helped removal of the excess liquidity in the markets, which would otherwise have to be done through open market operations.

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