In the decade after the 2008 financial crisis, global central banks and institutions have been bingeing on US treasury bonds because they ticked all the boxes of safety, liquidity, and returns. This trend is now reversing as the relentless rise of the greenback has triggered central banks to take measures for their own economies.
That has meant that the biggest buyers of US treasuries are now turning sellers as they step in to shore up their own markets.
In 2021, Japan, China, United Kingdom, Ireland, and France were the top buyers of US treasury notes that have turned net sellers in the first seven months of 2022, data from the US treasury department shows.
In total, foreign investors and institutions sold a massive $246 billion worth of US treasuries during this period. That’s a 3.2 percent drop in their holdings within a few months as against a 9 percent build-up in the year 2021. The treasury department will release data for August next week and it is expected that the holdings will come down further.
This selling pressure is one of the reasons behind the sharp 13 percent fall in the US Treasury total return index this year. In short, holding US treasuries has been disastrous for investors.
What does this have to do with the Reserve Bank of India (RBI)? The RBI invests its foreign exchange in securities that are liquid and safe, such as government bonds and bank deposits. As of July, India held $202 billion worth of US government bonds. That translates to roughly 27 percent of the forex reserve pile at that time.
The RBI must mark its holdings to market prices at the end of every week per its accounting policy. The mounting mark-to-market losses due to the surge in US treasury yields has eroded the value of the central bank’s foreign exchange pile. Indeed, Governor Shaktikanta Das had pointed out that more than half the fall in forex reserves has been due to valuation changes. The RBI is exposed to valuation risk due to the dollar’s rise, as well as interest rate risk from the rise in bond yields.
Sure, the erosion from the mark-to-market hit on bonds is optical as the losses booked are notional. That said, an optically worsening forex reserve position is enough to worry the market.
Forex reserves have dropped by $105 billion in the past one year, triggering anxiety that the central bank is losing its firepower to defend the rupee. As global central banks continue to sell US treasury bonds, the RBI will have to face the double whammy of valuation erosion and mark-to-market hit on its forex reserves portfolio.
At the same time, the RBI has been buying US treasury notes during the period when other major investors were net sellers. As such, for the RBI there aren’t many options to invest its forex reserves in. After all, the US bond market is the largest and most liquid globally.
Compared to the pain across UK government bonds in recent weeks, US treasuries look better by way of a smaller loss to investors. That said, as institutions globally continue dumping government bonds of major economies, the ones holding these papers, such as the RBI, would need to contend themselves with big losses in the short-term. Tactical purchases and active management may reduce the pain somewhat. But when large bond markets bleed, India’s central bank would need to feel the pain too.