Asia is growing and so is its Forex Reserve

IMF has forecasted the US to grow by 2% this year and the world economy to grow by 5.2% which in turn means the growth in Europe, Japan, and emerging markets including China and India would compensate for a weaker US.

Industrialised countries are facing more and more competition from Asian emerging markets where Asian products are not just competing on price alone but trying to become market leaders in their respective areas.

The increased FDI and FII investments being made in these Asian economies (particularly India and China) attracted by high growth has led to very high levels of Foreign Exchange Reserves with these countries which is getting difficult for them to handle.

Asia has come a long way since 1997, whereby banks have become more stable, currency reserves have been amassed, and governments are modernizing and integrating financial systems. Russia has a reserve of $450 billion up from $7.8 billion of 1998; South Korea has $250 billion from $52 billion of 1998, China has more than $1.2 trillion and India has more than $200 billion which is further growing.
Most of the forex reserves of these Asian Economies (especially China and India) are invested in US short term treasury. China controls its inflation through investing in US debt instruments which is known as Chinese Sterilisation effect.

It is quite evident that the government due to various reasons such as depreciating US dollar and also desire to receive higher returns want to invest their forex reserves in more efficient way, a recent example of which was the Chinese government invested $3 billion out of their $1.2 trillion reserves in Private Equity firm Blackstone based in New York.
However, India still needs to start on this front.
The rationale for building high reserves is to prevent financial crisis caused by sudden and large outflow of capital.

State of India:
India to some extent is still not potent enough to make investments in PE or Hedge Funds like other countries such as Singapore and UAE who have independent investment arms and China who has started investing recently.
This is mainly due to the risk averse nature of the government and public sector and also due to the heavy inflow of FIIs who may start exiting at the slightest indication of a negative market. Hence to prevent another crisis from occurring, the country needs high reserves, however definitely a portion of this colossal reserve can be put in investments yielding higher returns, however the big question which is haunting the RBI is how much? How Much of the reserves if invested in riskier investments would not harm the economy, is the question which needs to be answered.

(RBI is trying to cap the External Commercial Borrowing (ECB) to prevent the huge inflow of Dollar, which puts inflationary pressures on the economy. RBI has to release the equivalent of rupees to absorb the dollar inflow, so as to neutralise its effect on the money market. This leads to an increased money supply in the economy, adding to inflation.)


Implications for US:
Things can change abruptly if US economy enters recession; even the slightest insinuation that the Chinese investments are at a risk would run fast incase of a slight fiscal problem.
The abrupt withdrawal of all the money in the tune of trillions of Dollars can be a real run which can collapse the US bond market. The yields on a sudden can shoot up to 10% or higher. The stocks will crash immediately. The financial meltdown will occur in the trillion dollar meltdown that will be unstoppable.
The surging Current Account deficit of US has always been aggravated by the investments in US Treasuries from developing economies.

Conclusion:
Ten years ago, it would have been difficult to believe that the developing countries of Asia would finance the old world with their foreign exchange reserves accumulated through current account surpluses. However, today it is a reality which cannot be disregarded.
Asian emerging markets and commodity exporting countries will continue to finance the mature economies.
This unnatural phenomenon of funds moving from developing countries to developed countries should be the other way round for the better development of the global economy and also the improvement of developing countries.