The Hindu Business Line : Improving returns from excess reserves

Third World countries are never short of advice from the First World, World Bank, IMF, etc. It is difficult to think of any visiting Western economist who does not have something to say about our policies. Usually, it is homilies on the virtues of free markets and fiscal and monetary discipline.

The latest in the long list of noted visitors is Mr Lawrence Summers, President of the Harvard University. His CV is extremely impressive. Apart from being a distinguished academic, he was Treasury Secretary in President Clinton's administration. Earlier, in a stint in the World Bank, he earned some sort of notoriety, advocating the export of environmental pollution to the Third World. A rich country attaches more value to a clean environment than do the people of a poor country. So shift all polluting industries to the developing world and compensate it for the damage. In utilitarian terms, everyone is better off. It is a non-zero sum game - all are winners. And, of course, for him, it made perfect economic sense.

His theme

In an India speech, Mr Summers departed from convention. (It must have been a relief to our economy managers and central bankers to be spared the inevitable warnings about loose monetary and fiscal policies). His theme was the high level of forex reserves in several Third World countries and the poor returns from these holdings. Safety and liquidity are paramount in the management of reserves and these demand that reserves are held mostly in G-7 central banks or Treasury bills of the highest quality and the lowest yields. The usual favourite in the latter are those issued by the US Government.

Bonds are no better. Investments in G-7 bonds too are characterised by low yields, given the low level of global interest rates.

Every country needs a minimum level of reserves for imports, debt-servicing and market intervention to ward off possible speculative attacks on the currency.

Hand over reserves

Mr Summers advocates handing over reserves in excess of this minimum to an institution such as the IMF or the World Bank, who would employ global fund managers to invest the reserves for the best possible returns. The intermediation of the Bretton Wood twins would lend respectability to an action which might otherwise smack of irresponsibility or corruption if funds were to be placed directly with (say) a hedge fund.

To buttress his argument, Mr Summers points out that endowments of US universities (including Harvard) have earned annual returns of 10 per cent and more on their corpus with proactive management. If the fund manager can achieve this, Third World Governments would have that much extra to spend on their investments and welfare programmes.

Times being what they are, even central banks cannot shy away from the responsibility of improving returns on the reserves in their custody. Mr Summers' idea is timely and merits the most serious consideration in global forums.

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