Have accountability in forex management

Financial Express, 20 December 2004

Good governance is required when a government agency trades on markets

What part of India's foreign exchange reserves does the RBI hold in US dollars, a declining currency? How does it make this decision? Who is held accountable if it loses Rs 50,000 crore in its portfolio management?

Think of any other government agency with a portfolio worth Rs 5,00,000 crore. A 10% profit on this portfolio would be a profit of Rs 50,000 crore and a 10% loss would be a loss of Rs 50,000 crore. These are big sums of money for e.g., when compared with the Rs 40,000 crore required for the Employment Guarantee Act.

How would we deal with such a situation? Good governance requires many steps. We would start with expert committees which would argue, from first principles, what this agency should be doing and why. There would be a governance structure where wise men would be put in charge of decisions. There would be a clear policy document clearly laying down every step regarding what should be done. There would be copious transparency, where every move of the government agency would be carried out in the public domain. There would be no arbitrary exercise of power. When any decision is taken which does not flow from the written manual, there would be clear accountability for profits or losses. CAG and Parliament would ask why public money is being wasted, and heads would roll when losses are incurred.

Remarkably enough, the RBI which is sitting on a portfolio of roughly Rs 5,00,000 crore, doing speculative portfolio management, has none of the above structures.

The reserves portfolio is invested in a basket of currencies across the world. Curren-cies fluctuate dramatically. The dollar-euro exchange rate, or the dollar-pound exchange rate, have a volatility which is roughly half the volatility of an equity index. So there is enormous volatility in this portfolio management.

In the private sector, traders manage portfolios, but are held accountable. The secretive trading by RBI staff constitutes power without accountability. There is also a major gap between RBI staff and the private sector in terms of skills in these trading functions.

Indian reserves portfolio management has been pretty bad
The public should know what RBI is doing when speculating with its money
The Indian reserves portfolio management has been pretty bad. We have clung to the dollar for years, while it was very clear that the dollar was a sinking ship. As the value of the dollar has gone down, our reserves portfolio has effectively depreciated. We only have the illusion of stability because we insist on doing measurement in rupees or in dollars. This is not to suggest that there was malfeasance in these losses. All speculation is risky, and with a 50% chance, it will always be the case that losses are made. The point of this article is to focus on good governance. When a government agency does speculative portfolio management, good governance requires many things, in terms of due process, accountability and transparency. None of those precepts of good governance are being followed today.

Consider transparency. While FII trading on the Indian equity market is reported daily, RBI's trading on the currency market is only reported monthly. Further, there is a huge time lag. As of mid-December, data for RBI trading is only shown for September. What RBI was doing in October, November and half of December is completely non-transparent. This is not good governance. In non-transparency lies the exercise of arbitrary power.

How should this situation be remedied? The following five- point action programme should be put in place. An expert committee consisting of economists from outside the RBI which will write a policy document on how and when RBI should buy or sell on the currency market should be formed. This committee should turn into a standing committee which can regularly oversee RBI's trading and write quarterly reports about what was done with public money. There should be a complete process manual defining what the RBI employees would do to remove all discretion. The manual should be made public so that everyone knows what the RBI is doing when it is speculating with public money. There should be daily disclosure of the complete portfolio and of every single trade that is undertaken on a same-day basis. And every situation where the staff chooses to diverge from the process manual should generate an exception report, which is reported to the standing committee with explanations.

Ila Patnaik