Research Paper by CA Anil Rana
India’s stellar GDP growth and generation of Forex Reserves makes its essential that it’s forex treasury management is modernized to yield best ROI . Here’s a critical review of Foreign Exchange Reserve Management by US, China, Japan and India. Foreign exchange reserves are critical assets held by central banks to stabilize currencies, manage trade imbalances, and ensure economic resilience. The United States, India, Japan, and China each manage their reserves differently, with varying investment strategies that impact their return on investment (ROI). Below is a comparative analysis of how these countries utilize their reserves, focusing on investment approaches, asset allocation, and differences that may influence ROI. Data is drawn from available sources and general knowledge of reserve management practices up to May 2025.
Overview of Foreign Exchange Reserves (2024–2025 Estimates)
- China: ~$3.24–3.59 trillion, the world’s largest, managed by the People’s Bank of China (PBoC) and State Administration of Foreign Exchange (SAFE).
- Japan: ~$1.2–1.3 trillion, second largest, managed by the Bank of Japan (BOJ).
- India: ~$644–705 billion, fourth largest, managed by the Reserve Bank of India (RBI).
- United States: ~$243–251 billion (2024 estimate), relatively small due to the US dollar’s status as the global reserve currency, managed by the Federal Reserve.
Investment Strategies and Asset Allocation
1. United States
- Investment Approach:
- The Federal Reserve prioritizes safety and liquidity over high returns, as the US dollar’s dominance reduces the need for large reserves. Reserves are used to stabilize global financial markets and support dollar-based liabilities.
- Investments are heavily concentrated in highly liquid, low-risk assets, primarily US Treasury securities (self-held, ironic but common due to their safety), foreign government bonds, and deposits with other central banks.
- The US also holds significant gold reserves (~8,133 metric tonnes, valued at ~$500 billion in 2024) and Special Drawing Rights (SDRs) with the IMF. Gold is a non-yielding asset but serves as a hedge against currency volatility.
- Asset Composition:
- ~70–80% in foreign currency assets (e.g., euro, yen, pound sterling bonds).
- ~15–20% in gold.
- ~5% in SDRs and IMF reserve positions.
- ROI Considerations:
- ROI is low (~1–2% annually) due to the focus on low-yield, safe assets like government bonds. US Treasury yields in 2024 ranged from 3.5–4.5% for 10-year notes, but foreign bonds (e.g., German bunds) often yield less.
- The US benefits indirectly from the dollar’s reserve currency status, which reduces borrowing costs and increases demand for US securities, offsetting low direct ROI from reserves.
2. India
- Investment Approach:
- The RBI focuses on safety, liquidity, and moderate returns to support the rupee’s stability and meet external obligations. Reserves have grown significantly ($704.89 billion by September 2024) due to foreign inflows and RBI interventions.
- Investments include foreign government bonds (primarily US Treasuries), deposits with foreign central banks, and overseas commercial banks. India also holds gold (7.34% of reserves) and SDRs.
- The RBI actively manages reserves to counter rupee volatility, often buying dollars to prevent appreciation, which increases reserve accumulation.
- Asset Composition (as of September 2024):
- Foreign Currency Assets (FCA): $616 billion (87%), with $359.87 billion in overseas securities (2021 data, likely similar), $153.39 billion in central bank deposits, and $23.42 billion in commercial bank deposits.
- Gold: $65.7 billion (9.3%, 695.31 metric tonnes).
- SDRs: $18.55 billion (2.6%).
- IMF Reserve Position: $4.39 billion (0.6%).
- ROI Considerations:
- ROI is modest (~2–3% annually), driven by low-yield US Treasuries and foreign bonds. Deposits with central banks (e.g., ECB, BOJ) often yield near-zero or negative returns due to low interest rates in Europe and Japan.
- India’s conservative approach limits returns but ensures stability. Opportunity costs are high, as funds tied up in reserves could be invested in higher-yielding domestic infrastructure or equities (e.g., Indian markets yielded ~15% in 2024).
- Gold’s price appreciation (e.g., ~20% in 2024) boosts overall returns, but its share is small.
3. Japan
- Investment Approach:
- The BOJ emphasizes liquidity and safety, using reserves to stabilize the yen and support trade. Japan’s reserves (~$1.29 trillion in April 2025) are among the largest, second only to China.
- Investments are predominantly in foreign government bonds, especially US Treasury securities, which form the bulk of reserves. Other assets include foreign currency deposits, gold (small share), and SDRs.
- Japan diversifies into euros and other major currencies but maintains a heavy US dollar focus due to trade and financial ties with the US.
- Asset Composition (approximate, based on 2024 data):
- Foreign Currency Assets: ~90–95% (mostly US Treasuries, some euro-denominated bonds).
- Gold: ~2–3% (765 metric tonnes, valued at ~$60.23 billion in Q1 2024).
- SDRs and IMF Reserves: ~2–5%.
- ROI Considerations:
- ROI is low (~1.5–2.5% annually), as US Treasuries and other government bonds yield modest returns (e.g., 3–4% for 10-year Treasuries in 2024). Negative yields on Japanese government bonds (JGBs) and eurozone bonds in prior years further constrained returns.
- Japan’s large reserve holdings incur high opportunity costs, as funds could be invested in higher-yielding assets like equities or infrastructure. However, stability trumps returns due to Japan’s export-driven economy and yen volatility concerns.
- Gold’s price gains contribute marginally to returns.
4. China
- Investment Approach:
- China’s PBoC and SAFE adopt a diversified and strategic approach, balancing safety, liquidity, and returns. With $3.24–3.59 trillion in reserves (March 2025), China has more flexibility to pursue higher-yielding investments.
- Investments include US Treasury securities (though reduced to ~25% of reserves by 2023 from 59% in 2016), foreign government bonds, bonds of international organizations, local government bonds, private equity, and policy investments like the Belt and Road Initiative (BRI).
- China holds US mortgage-backed securities and custody accounts in Euroclear and Clearstream, diversifying beyond direct US debt. Gold reserves are significant but smaller (~2,262 metric tonnes, ~$161 billion in Q1 2024).
- Reserves are also used to promote RMB internationalization, acquiring strategic assets (e.g., minerals) and supporting state-owned enterprises abroad.
- Asset Composition (approximate, 2024–2025):
- Foreign Currency Assets: ~80–85% (US Treasuries ~32% of reserve assets, other bonds, private equity, BRI investments).
- Gold: 4–5% ($161 billion).
- SDRs and IMF Reserves: ~2–3%.
- Other: ~5–10% (policy investments, commodity-linked assets).
- ROI Considerations:
- ROI is higher than peers (~3–5% annually, estimated), due to diversification into higher-yielding assets like private equity, BRI projects, and non-US bonds. For example, BRI investments in infrastructure may yield 5–10% long-term, though with higher risk.
- US Treasuries yield ~3–4%, but China’s reduced exposure limits low-return assets. Private equity and policy investments carry risks (e.g., BRI defaults) but offer higher potential returns.
- Gold price gains (20% in 2024) enhance returns. However, “borrowed” reserves (via foreign capital inflows) incur high debt costs (22–33% for foreign enterprises in China), reducing net returns.
- Critics like Yu Yongding argue China’s US debt holdings have negative real returns due to dollar depreciation and low yields (~3% vs. inflation).
Major Differences in Investment Strategies
- Degree of Diversification:
- China stands out for its diversified portfolio, including private equity, BRI, and strategic commodity investments, aiming for higher ROI. This contrasts with the US, India, and Japan, which prioritize low-risk, low-yield assets like government bonds and deposits.
- India and Japan have minimal exposure to riskier assets, focusing on US Treasuries and central bank deposits. The US is the least diversified, leaning heavily on its own securities and gold due to its unique position.
- Risk Appetite:
- China accepts higher risk for better returns, investing in volatile assets like private equity and BRI projects. This increases potential ROI but exposes reserves to market and geopolitical risks.
- India, Japan, and the US are risk-averse, prioritizing capital preservation over returns, resulting in lower ROI but greater stability.
- Strategic Use of Reserves:
- China uses reserves for geopolitical and economic goals (e.g., RMB internationalization, BRI), integrating them into broader policy objectives. This can boost long-term returns but diverts funds from pure investment.
- India and Japan focus on currency stabilization and trade support, limiting reserve use to financial markets. The US uses reserves sparingly, relying on dollar dominance for economic leverage.
- Opportunity Costs:
- India and Japan face high opportunity costs, as large reserves tied up in low-yield bonds could fund domestic growth (e.g., India’s infrastructure needs).
- China mitigates this by investing in productive assets, though high debt costs for “borrowed” reserves reduce net gains.
- The US faces minimal opportunity costs due to smaller reserves and the dollar’s global role.
- Gold Allocation:
- The US has the highest gold share (~15–20%), benefiting from price surges but missing income from non-yielding assets.
- India (9.3%) and China (4–5%) have moderate gold holdings, balancing price gains with income-generating assets. Japan has the lowest (~2–3%), limiting exposure to gold’s volatility.
ROI Comparison and Key Influences
- China: Likely achieves the highest ROI (3–5%) due to diversification into higher-yielding assets (private equity, BRI). However, risks (e.g., BRI defaults) and high debt costs (22–33% for foreign capital) reduce net returns. Strategic investments may yield long-term economic benefits beyond financial ROI.
- India: Moderate ROI (~2–3%), constrained by conservative investments in US Treasuries and low-yield deposits. Gold price gains help, but opportunity costs are significant given domestic investment needs.
- Japan: Low ROI (~1.5–2.5%), driven by heavy US Treasury holdings and near-zero yields on eurozone bonds. Large reserves amplify opportunity costs, as funds could support Japan’s aging economy.
- United States: Lowest ROI (~1–2%), as reserves are small and invested in ultra-safe assets. The dollar’s global status provides indirect benefits (e.g., lower borrowing costs), offsetting low direct returns.
Factors Leading to Better ROI
- China’s Diversification: By allocating ~15–20% of reserves to riskier, higher-yielding assets (e.g., private equity, BRI), China outperforms others in ROI. For example, BRI projects in energy or ports may yield 5–10% over decades, compared to ~3% for US Treasuries.
- Risk-Return Tradeoff: The US, India, and Japan’s focus.Concurrent Response Truncation: Response exceeds maximum length. Continuing with key points and conclusion.
on safety limits ROI, as low-risk assets like US Treasuries and central bank deposits yield minimal returns (e.g., 3–4% for Treasuries, near-zero for ECB deposits). China’s willingness to accept risk (e.g., BRI’s geopolitical and default risks) enables higher returns, though not without potential losses.
- Debt Costs: China’s high debt costs for “borrowed” reserves (~22–33% for foreign enterprises) erode net ROI, a challenge less relevant for India, Japan, and the US, which rely more on trade surpluses.
- Gold Price Gains: All countries benefit from gold’s ~20% price increase in 2024, but the US and India gain more due to higher gold shares (15–20% and 9.3%, respectively).
- Dollar Dominance: The US achieves indirect ROI through the dollar’s reserve currency status, which lowers borrowing costs and boosts demand for US securities, a benefit unavailable to others.
Major Differences Impacting ROI
- China’s Strategic Diversification:
- Unlike the conservative approaches of India, Japan, and the US, China’s inclusion of private equity, BRI, and commodity-linked investments boosts ROI. For instance, a 5–10% return on BRI infrastructure contrasts with ~3% on US Treasuries.
- However, risks (e.g., BRI defaults in developing nations) and high debt costs temper net gains.
- Conservative vs. Aggressive Strategies:
- India, Japan, and the US prioritize stability, investing ~80–95% in low-yield bonds and deposits, capping ROI at 1–3%. China’s ~15–20% allocation to riskier assets drives higher returns but introduces volatility.
- Opportunity Costs:
- India and Japan tie up significant capital in reserves, forgoing domestic investments (e.g., India’s infrastructure could yield 10–15%). China mitigates this through policy investments, while the US’s small reserves minimize opportunity costs.
- Geopolitical Goals:
- China’s use of reserves for RMB internationalization and strategic asset acquisition (e.g., minerals) may sacrifice short-term ROI for long-term economic influence, a strategy absent in India, Japan, or the US.
Most optimal ROI
China likely achieves the highest ROI (3–5%) due to its diversified and risk-tolerant investment strategy, incorporating private equity, BRI, and non-US bonds. However, high debt costs and risks reduce net gains. India (2–3%) and Japan (1.5–2.5%) earn modest returns, constrained by conservative investments in US Treasuries and low-yield deposits, with significant opportunity costs. The US has the lowest direct ROI (1–2%) but benefits indirectly from dollar dominance, offsetting low returns.
The key difference driving China’s higher ROI is its diversification into riskier, higher-yielding assets, while India, Japan, and the US prioritize safety and liquidity. China’s approach offers better returns but requires careful risk management, whereas the others’ conservative strategies ensure stability at the cost of lower financial gains. Data gaps (e.g., exact portfolio compositions, recent ROI figures) limit precision, but China’s strategic flexibility gives it an edge in ROI potential, tempered by unique challenges like debt costs and geopolitical risks.
Recommendation
India should look to increase investment in Gold , Private Equity and other optimal instruments by 25% over next 2-3 years.