Washington, July 7 (IANS) A noted American economist is advising developing countries like India with extra cash to put much of their excess reserves into stocks instead of US treasury bonds to earn about 100 billion dollars annually - much more than all the foreign aid they get.
For at an annual return of 5 percent - a conservative estimate for the long-run yield on a sensible stock portfolio - on just two of the several trillion dollar excess reserves, could produce average annual yields of about $100 billion, said Harvard University president Lawrence Summers.
'Therein lies potential for realizing economists' fondest wish: an almost free lunch,' said the former chief economist at the World Bank in a lecture at the Center for Global Development, a Washington think tank.
Summers, who also served as US treasury secretary under President Clinton, argues that too often developing countries in Asia, Eastern Europe, Latin America and Africa are passing up much more lucrative investments in favour of safe, but low yielding US treasury bonds.
The central banks of these countries apparently didn't realise that the return on excess reserves, defined as extra funds above the amount needed to cover foreign debts coming due within one year, invested in the US bonds, 'will be zero' after inflation and currency changes are factored in, he said.
Summers lamented that this is happening in societies where hundreds of millions of people are still desperately poor, when they could earn more than all the rich countries in the world spend on foreign aid to poorer countries each year.
The phenomenon is occurring not only in countries such as China, that are well known for amassing vast quantities of US bonds, but also in many poor countries that, while holding much smaller amounts than China, still hold sums that are sizable relative to their gross domestic products.
Libya, for one, has 91 percent of its GDP in excess reserves of $35 billion, followed by Botswana with 66 percent of $6 billion, Algeria with 51 percent of $51 billion and Malaysia with 45 percent of $59 billion.
India with $108 billion dollars, forming about 14 percent of its GDP, has the third highest after China and Russia. China's excess reserves of $724 billion dollars make up about a third of its GDP, while Russia's $118 billion account for 15 percent, according to the Center's data as of the third quarter of 2005.
Summers acknowledged several problems with his proposal, such as the danger that central bankers would start gambling with their reserves by putting them into even more risky investments than stocks.
His proposal is based on fundamental shifts in the global financial system, in particular an immense build-up in the reserves of foreign exchange held by developing countries' central banks. Those reserves have grown as the United States, with its burgeoning trade deficit, imports goods from abroad.
The dollars Americans spend on foreign products eventually end up in the hands of central banks overseas, and the central banks invest the proceeds largely in US government securities.
They do so in part because they want to protect themselves against financial crises of the sort that struck Thailand, Indonesia, South Korea, Russia, Brazil and Argentina a few years ago.
But the reserves that have piled up, Summers said, are 'far in excess of what is necessary' to defend against a crisis -- probably more than $2 trillion too much, he estimated, based on the most commonly used guidelines.
In his view, the upshot is the central, global financial irony of our times -- countries that need capital to finance rapid development are shipping more money to the United States than is flowing in the opposite direction -- and it is their official policies to do so.
'No one could suppose that these are going to be high-return investments,' he said, because the interest rates on US bonds are about two percent after inflation, and for developing countries even that paltry yield would be wiped out if -- as many analysts expect -- the dollar declines against other currencies.
© 2006 Indo-Asian News Service | 
