"We should look at cross-investing in each others' countries. This can be controversial because our credit ratings are low. But we should explore it."

SAARCFinance, a regional forum of central bankers of the eight-nation South Asian Association for Regional Co-operation (SAARC), is having a two-day seminar to boost their forex management skills and improve returns.

Head of the banking studies unit of the Sri Lanka's central bank, Udeni Alawattage, said key Asian nations had seven times the foreign reserves of the European Union area with China having 1,800 billion dollars and India 300 billion dollars.

Flawed Frameworks

Foreign exchange reserves, which central banks in Asia and some developing countries accumulate, are a result of central bank intervention in forex markets.

It is a consequence of operating a 'soft-pegged' exchange rate, where a central bank runs its money supply out of a mixture of foreign and domestic assets with a bias towards foreign reserves.

Such countries also have a tendency to 'fix' or maintain a parity with the exchange rate of one intervention 'reserve' currency, usually the US dollar.

Developed countries like the US or EU have low levels of foreign reserves because they do not intervene in foreign exchange markets and have a free floating exchange rate with a commitment towards low inflation.

Reserve currency central banks run their money supply out of domestic assets, which is usually the debt of their own government now, though it was gold before the collapse of the Bretton Woods agreement in 1973.

Reserve currency central banks therefore do no appropriate foreign exchange flows from other economic players and cause unnecessarily high interest rates.

There has been a growing realization that soft-pegged monetary frameworks are fundamentally flawed, prone to both high inflation and currency crises, especially among monetary economists who hold the so-called 'bi-polar view' of exchange rate systems.

They have pointed out that as a result of increasing understanding about monetary systems in developing countries, soft-pegged exchange rate central banks have been going out of fashion.

The process of 'hollowing out' of the spectrum of monetary systems in favour of floating rate central banks on one side and hard pegs (currency boards), currency unions like the EU and dollarization on the other, has accelerated after the Asian currency crisis.

The International Monetary Fund has also been facing problems with earning revenue as fewer central banks are now getting into currency crises.

The problem of appropriating and exporting capital from economic players in developing countries, via excessive foreign reserve accumulation greater than the domestic money supply, is also a relatively benign negative consequence of soft-pegged central banking.

Governor Cabraal says, while Asian central banks have bought low yielding government or state-backed securities in developed nations, developing countries were borrowing money at high rates from the same developed nations for infrastructure financing.

Risky Returns

Cabraal says central banks will have to look at innovative and non-traditional methods to improve their returns, though there were new risks in trying to push up returns.

Before the sub-prime crisis, US mortgage giants such as Freddie Mac and Fannie Mae were considered suitable for central banks to invest in, but the high defaults in housing loans has now changed that view, Cabraal said.

Countries like China have gone to extreme lengths to invest foreign reserves in high-risk US private equity firms like Blackstone capital, whose share prices have since plummeted.

Exchange rates in South Asia have been volatile and weak, hit by wide fiscal deficits which are then accompanied by monetary loosening, due to a weak grasp of monetary policy as well as political intervention in rate setting.

At the moment Pakistan is suffering from currency pressure and has been rapidly losing reserves.

Corrected. Reserve data of India and China