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Decimal Digest
07 Feb 2011

Value of Dollar and Solvency of Developing World Central Banks

Last week, Nassim Taleb, a perceptive writer and money manager, told Bloomberg that “the “first thing” investors should avoid is U.S. Treasuries and the second is the dollar…As skeptical as I am about Europe, I prefer it by far to the United States.” This comment echoes the comment of PIMCO‟s Bill Gross, earlier in January 2011, stating that “Gilts and Treasury bonds may need to be „exorcised‟ from model portfolios”.

We in India know that RBI holds foreign exchange reserves of nearly USD 300 billion, mainly in the form of short term claims on “safe haven” sovereigns. As more and more commentators are expressing doubts on the safe haven status of Dollar and Euro, we thought it would be appropriate to do sensitivity analysis on the balance sheet of RBI.

The above table shows that about 75% of RBI balance sheet consists of claims on foreigners. On the liability side, its networth is just below 25% of its assets. In other words, a 33% fall in the value of foreign assets in INR terms would make the networth of RBI go below zero, a sufficient cushion in normal market conditions.

Now, let‟s look at the balance sheet structure of PBOC

The Net Worth of PBOC is at just 3% of its total assets. Also the fact that the foreign asset holdings of PBOC are equivalent to over 70% of China.s GDP provides further food for thought. In contrast to the RBI, the networth of PBOC can go below zero, if the RMB value of foreign assets of PBOC falls by just 4%. This weak link in the global financial markets can cause hurt to the real economy, because, if the treasuries fall in value rapidly, then, given the size of RBOC.s balance sheet, China may have to resort to depreciation of RMB, just to maintain RBOC.s positive networth.


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