Optimal versus adequate level of international reserves: evidence for Turkey

The determination of international reserve balance for emerging economies is part of the efforts to strengthen the immunity of these economies to crises. However, there is still evidence on crises even for the countries with large foreign reserves. It has usually been experienced that the countries with greatest need for reserves economize more than others on their holdings since they might underestimate the cost of crisis. In this study, the official international reserves of Turkey are tested against optimality and adequacy. During 1988–2002, the actual reserves fell short of both the optimal and the adequate levels. They are only optimal when the expected cumulative contraction is about 5.2% of real GDP under crisis. However, early evidence from emerging economies and Turkey show that crises hit more heavily. Hence, it is found that the current financial structure in Turkey such as the absence of capital controls and a highly dollarized banking system necessitates more foreign reserves for preventing any future economic and/or financial shocks.     

Ein ökonometrisches Quartalsmodell für den monetären Sektor der österreichischen Wirtschaft

Summary This paper describes the development of a quarterly econometric model for the monetary sector oft the Austrian economy. The model consists of 8 behavioural equations and 3 definitions. The equations were estimated by OLS using absolute differences on an annual basis of quarterly time series data. The sample period covers 44 quarters (1^st quarter of 1960 to 4^th quarter of 1970).Behavioural equations were estimated for three components of bank reserves: net free reserves, borrowing from the central bank and short-term net foreign position. The instruments of central bank policy (discount rate, minimum reserve requirements and open market operations), changes in net foreign assets of the central bank and bank deposits constitute important determinants of these reserve components. Central bank borrowing and net foreign assets appear to be planned aggregates, whereas net free reserves have a more residual character. A further equation explains banks' net investment in long-term fixed-interest securities (bonds). Another group of equations was estimated for non-banks' demand for money (defined in the wide sense). Separate equations exist for currency, demand deposits and (private) saving deposits (no satisfactory explanation could be found for time deposits). These monetary aggregates are determined as usual by income variables (the distribution of disposible income between wage and non-wage income) and by the interest rate (effective interest rate of newly issued bonds). Several additional variables improved the degree of explanation. Finally, total bank loans were found to be determined by fixed and inventory investment and by loans from abroad.These structural equations form a linear recursive system which can be solved via reduced form. In order to study the properties of the model several tests were performed. The dynamic solution (values generated by the model were used for lagged endogenous variables) shows that errors do not cumulate in the course of time. As an, example of multiplier analysis the effects of a change in the net foreign reserve assets of the central bank on several endogenous variables are considered. Policy simulations are run for the cases of changes in the discount rate, in minimum reserve requirements and disposible income (e. g. as a result of a change in income tax rate).From the satisfactory results of these tests we conclude that our model represents the structure of the Austrian monetary sector quite well.

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Die Verfasser danken Herrn Professor Dr.E. Streissler für zahlreiche Anregungen.     

Surplus liquidity,central bank losses and the use of reserve requirements in emerging markets

Since the turn of the millennium, stocks of foreign reserves held by central banks in many emerging markets and developing countries have exceeded currency in circulation. To steer money market rates, these central banks have been absorbing liquidity from, rather than providing it to, the banking sector in their regular monetary policy operations. When interest rates in countries with major reserve currencies are low, the yield on foreign reserves is low. A higher interest rate on liquidity‐absorbing operations may expose central banks to losses. Although a central bank is not a profit‐maximizing institution, central bank losses can undermine the independence of the central bank. Using data for a large panel of central banks, this paper provides some evidence that central banks tend to apply low‐remunerated reserve requirements when profitability is at stake.     

Asymmetric stabilizing impact of international reserves

This article studies international reserves’ nominal exchange rate stabilizing impact in emerging markets and developing countries, with a particular focus on its nonlinearity and asymmetry across different states of the economy. Using the fixed-effects and dynamic panel threshold models, we find the reserves to short-term debt threshold ratio after which the marginal stabilizing effect of reserves begins to fall during tranquil times. Such diminishing returns, however, do not appear to exist even at the excessive level of reserves during the global financial crisis, partly justifying precautionary demand for international reserves. These results call for extending reserve pooling or swap arrangements to enhance efficiency of reserve management by holding adequate, rather than excess, international reserves with an access to emergency lending during the crisis.     

我国外汇储备币种结构与收益率的一个估计

文章在假设持有美元、欧元、日元三种币种结构的前提下,构建了我国外汇储备增长率的分解方程,利用Recursive Residual和虚拟变量法来处理异常点,同时借助CUSUM检验确认了2003年8月为结构性断点,继而分为两个子样本分别估计,并得出:(1)2003年8月前,我国外汇储备平均收益率约为3.66%,欧元资产比例大约为11.78%;2003年8月后欧元资产比例上升至21.79%,收益率微升至4.03%.(2)利用估计出的币种结构进一步对收益率进行调整,并将调整后的收益率与我国同期的GDP增长率和FDI投资回报率进行对比,说明改变现行的消极管理模式为强调市场化手段、旨在提高收益率为特征的积极管理模式的必要性,同时针对积极型外汇储备管理模式给出了进一步的研究展望.     

The Impact of a Disorderly Resolution of Global Imbalances on Global Wealth

Partly reflecting structural advantages such as liquidity and strong investor protection, foreigners have built up extremely large positions in US (as well as other dollar‐denominated) financial assets. This paper describes the impact on global wealth of an unanticipated shock to US financial markets. For every 10 per cent decline in the dollar, US equity markets, and US bond markets, total wealth losses to foreigners could amount to about 5 percentage points of foreign GDP. Four stylized facts emerge: (i) foreign countries, particularly emerging markets, are more exposed to US bonds than to US equities; (ii) over time US exposure has increased for most countries; (iii) on average, US asset holdings of developed countries and emerging markets (scaled by GDP) are very similar; and (iv) based on their reserves position alone, wealth losses of emerging market governments could on average amount to about 2¾ percentage points of their GDP.     

国际资本流动“突然停止”、消费平滑与最优外汇储备持有量*

通常认为外汇储备具有抵御外部冲击、平滑居民消费、增进社会福利的作用。循此逻辑,文章构建了三部门模型模拟了货币当局面临资本流动“突然停止”时,出于平滑消费目的的最优储备持有行为。研究发现：中国静态最优外汇储备量约占GDP的1926%;中国实际储备与最优储备的差额自2010年起稳定在18万亿美元;最优外汇储备量与“突然停止”发生概率及其导致的产出损失、短期外债规模、居民存款规模及危机时的资产置换比率、风险规避程度正相关,与银行备付金比率、国际风险溢价程度负相关;从危机应急的角度看,提高银行备付金比率、控制居民存款置换外币比例能有效节约外汇储备,但从长远来看控制国内短期外债规模、确保银行稳健运营才是应对国际资本“突然停止”风险的关键。     

What is Driving Reserve Accumulation? A Dynamic Panel Data Approach

Foreign reserve accumulation is a widespread phenomenon of recent years, particularly among emerging economies. Using a panel of 136 countries for the period 1973–2003, we demonstrate the need of using both a dynamic specification of the reserve demand equation and the system GMM estimator. These improvements change the results found by previous studies. Openness, regional imitation, persistence, an inverted U-shaped relationship between reserves and income level, and financial deregulation are the factors driving reserve hoardings. In contrast, reserves yield, and both trade and financial volatility are not statistically significant. Surprisingly, we find that countries with flexible exchange rate regimes have higher ratios of reserves to GDP. This result is robust to alternative exchange rate regime classifications.     

Impact of hurricanes strikes on international reserves in the Caribbean

ABSTRACT

In this study, we investigate the impacts of hurricane shocks on the international reserves of Caribbean countries. To this end, we use a panel VARX (Vector Auto-Regressive, with exogenous variables) with monthly data that allow us to account for external shocks (hurricane strikes). Our results show that for the whole sample, an increase in foreign reserves a month after the strike was followed by a decrease 2 months later. The increase can be explained by remittances and emergency foreign aid granted by the International Monetary Fund. Dividing the sample into middle-income and high-income countries shows that the increase is mainly due to the latter. This outcome may not be surprising given that production in Caribbean high-income countries is mainly due to manufacturing, off-shore banking and natural resources exploitation, which are all non-weather dependent sectors, while the middle-income countries are mostly dependent on weather-prone agriculture and tourism.     

对我国外汇储备问题的若干思考

我国国际收支的连年顺差,境外热钱不断流入,人民币升值压力的进一步增大,再加上我国长期实行的外汇制度等原因,使我国外汇储备大幅增加,而且已经是过量增长.而过多的外汇储备量,会给我国带来一定的风险和损失,包括通货膨胀带来的损失、美元贬值带来的损失以及存在的机会成本等.因此,要从控制增量、合理使用和配置资产以及改革现行外汇制度等角度出发,对我国外汇储备进行合理的控制.     

China's Banking Reform

This article discusses the main problems facing the Chinese banking system and concludes that, despite serious problems, the risk seems small that, in the near future, a financial crisis will occur that will pose severe problems for the international financial system. An internal financial crisis, however, could occur. Without government support, the economic viability of many of China's banks is questionable. The government and central bank authorities acknowledge the situation and have taken some steps toward reform. The most serious threat to the banking system lies in the accumulation of non-performing loans (NPLs)--many of them policybased loans extended by state-owned banks to money-losing state-owned companies with little expectation that they would be completely repaid. China has been taking measures to keep the problem from worsening and has created four asset management companies to dispose of NPLs that still have value. Since the Chinese economic reforms began in 1978, Chinese authorities have made significant progress in modernising their banking system, although they still have a long way to go. However, there are several ameliorating factors that still keep its financial and foreign exchange system viable. China's continued high rate of growth and high savings rate have funneled deposits into the banking system, while a $20-30 billion annual trade surplus together with an inflow of foreign direct investment at about $40 billion per year have resulted in an accumulation of foreign exchange reserves exceeding $200 billion. China does not carry an unusually heavy debt burden, either domestic or international, although its short-term borrowing in foreign currencies has been increasing. China does not currently face a serious risk of either a domestic or international liquidity crisis--unless, of course, a severe and prolonged world recession occurs that adversely affects Chinese exports as well as the inflow of foreign direct investment.     

The Role of Regime Type in the Political Economy of Foreign Reserve Accumulation

Authoritarian regimes have surpassed democracies in foreign reserve accumulation since the Asian Financial Crisis. Two prominent institutionalist theories could explain this diverging trend in reserves: First, the political business cycle theory, suggesting that reserves are reduced before an election. Second, the veto player theory, implying that a high number of veto players increases the de facto independence of central bankers, who are reluctant to invest in reserves. A time-series cross-sectional analysis for up to 182 countries over the period 1990–2013 shows that democratic governments tend to reduce their reserves before elections. While veto players do not affect reserves directly, a high number of veto players tends to limit a political business cycle before an election. Elections and veto players do not have an influence in authoritarian regimes. Election cycles tend to explain why democracies have relatively fallen behind in a period of massive reserve accumulation.     

The role of international reserves holding in buffering external shocks

An extended literature analyses the accumulation foreign exchange holding observed in many developing and emerging countries since the 2000s. Empirical studies on the self-insurance motive suggest that high-reserves economies are more resilient to financial crises and to international capital inflows volatility. They show also that pre-crisis foreign reserve accumulation explains post-crisis growth. However, some papers suggest that the relationship between international reserves holding and reduced vulnerability is nonlinear, meaning that reserve holding is subject to diminishing returns. This article devotes more attention to the potential nonlinear relationship between the foreign reserves holding and macroeconomic resilience to shocks. For a sample of nine emerging economies, we assess to what extent the accumulation of international reserves allows to mitigate negative impacts of external shocks on the output gap. While a major part of the literature focuses on the global financial crisis, we investigate this question by considering two sub-periods: 1995–2003 and 2004–2013. We implement threshold VAR model in which the structure is allow to change if the threshold variable crosses a certain estimated threshold. We find that the effectiveness of reserve holding to improve the resilience of domestic economies to shocks has increased over time. Hence, the diminishing returns of foreign reserve holding stressed in the previous literature must be qualified.     

THE GREAT RECESSION, “RAINY DAY” FUNDS,AND COUNTERCYCLICAL FISCAL POLICY IN LATIN AMERICA

We examine the fiscal policy options that were available to Latin American countries at the onset of the current global economic crisis, concluding that most of the major countries in the region possessed the fiscal space (as measured by credible fiscal sustainability and debt headroom) to run prudent countercyclical fiscal deficits. For those countries, the appropriate policy response involved a constrained fiscal expansion focused on productive public spending and financed by drawing on the “rainy day” funds—in the form of large stocks of foreign exchange reserves—that they accumulated in prior years, rather than by market borrowing. (JEL E62, E63, F34)     

Foreign exchange reserve adequacy and exogenous shocks

One of the traditional benchmarks in international macroeconomics is that a country should maintain reserves that can cover at least 12 weeks of imports. The notion of reserve adequacy, however, is not static and is intimately associated with the occurrence of financial crises as well as exogenous shocks, with many observers using the reduction in reserves below this benchmark as a sign of fragility. This article provides a benefit-cost type approach to evaluating reserve adequacy. The benefits of holding reserves are evaluated using a dynamic random effects probit model of financial crises while the cost of reserve holdings (output loss due to an over-investment in reserves) is obtained from a panel growth equation. Using the methodology outlined above, the study finds that in small states, the optimal holding of foreign exchange reserves is approximately 25 weeks of imports, approximately 13 weeks higher than the international rule-of-thumb. This estimate of optimal reserve holdings is interrelated with the economic characteristics of the country, particularly its fiscal stance. Indeed, this article finds that countries with a prudent public expenditure management framework in place are able to hold a smaller stock of reserves without necessarily impacting the expected growth for the country.     

High Capital Mobility and Precautionary Demand for International Reserves

The volatility of reserve increment and the opportunity cost of holding reserves play prime role in models of optimal demand for foreign reserves. Most empirical studies find significant rise in the response of reserve demand to volatility during the era of high capital mobility. In contrast, we find that volatility measured as rolling standard deviation of reserve increment provides upwardly biased estimates whereas conditional volatility derived from GARCH models eliminates such bias and provides elasticity estimate closer to the prediction of buffer stock model (0.5). Though the time varying elasticity estimates derived from Kaiman filter exhibit a sharp rise during crises period, it does not exceed theoretical prediction. The RBI’s intervention policy seems to be asymmetric; leaning with wind when rupee depreciates and leaning against wind when rupee appreciates. This evidence seems to indicate that the policy of exchange rate stability had an in-built objective of providing a competitive edge to exporters.

     

Asset-based Reserve Requirements: Some Reservations

Abstract

Thomas Palley's (2004) paper ‘Asset-based reserve requirements: reasserting domestic monetary control in an era of financial innovation and instability’ has radical implications for monetary policy and the operations of central banks in the money markets. This comment argues that Palley's proposal may be impractical today because it overlooks banks' holding of excessive reserves (or claims on such reserves), and because reserves allocated for particular kinds of business cannot be isolated in bank balance sheets or markets. In particular, once differential reserves are imposed on particular kinds of business, banks may respond to changes in reserve requirements by varying their assets in less predictable ways than the scheme suggests. A central bank's willingness to use differential reserve requirements will be inhibited by the current policy doctrine that emphasises control of a stable money market rate of interest. In any case, it is doubtful if interest rates or reserve requirements could have the specific targeted effects that Palley's model suggests.     

Empirical models of short-term debt and crises: Do they test the creditor run hypothesis?

A positive correlation between short-term debt and crises has been interpreted as evidence in favor of self-fulfilling creditor runs, which have been blamed for financial crises in developing countries. We show that this correlation can also be explained by a standard model of optimal borrowing without creditor runs. In such a model, imposing capital controls on short-term external debt is not Pareto-improving.     

The Determinants of Foreign Direct Investment in the Business Services Industry

Abstract

This report aims to identify the determinant factors of FDI in the business services industry by examining 20 variables and their impacts on attracting foreign investment in 33 sample countries plus Hong Kong. The results of this study indicate that system-related factor conditions and demand conditions have a strong correlation to FDI. Among the variables under system-related factor conditions, four (bribery and corruption, transparency, intellectual property rights (IPR), and ease of doing business) greatly influence the amount of FDI in the business services industry. Among the variables under demand conditions, three (the cost of living index, office rent, and GDP) are key. At the same time, this paper concludes that the aforementioned factors influence not only the business services sector, but the manufacturing industry's FDI as well. Another main finding of this paper is that the FDI in the business services industry is more frequently found in more developed economies. For the market seeking and efficiency-seeking FDI, the quality of system-related factor conditions and the size of GDP are of particular importance for FDI in the business services industry.     

International Reserves and the Composition of Foreign Equity Investment

This paper studies the effect of central banks' international reserve hoardings on the composition of foreign equity investment. Specifically, it examines whether reserves affect the share of foreign portfolio equity investment (PEI) in total foreign equity investment, which includes both PEI and foreign direct investment (FDI). Foreign investors' decisions regarding the location and the type of equity capital investment might be influenced by a country's level of international reserves. In a simple theoretical model, it is shown that higher reserves, thanks to their ability to lower exchange rate risk, reduce the risk premium of PEI. Hence, higher reserves are expected to increase the inflow of PEI relative to FDI. This hypothesis is tested for a sample of 76 developing countries during the period 1980–2010 using different estimation methods, model specifications and data samples. The results suggest that higher levels of reserves are associated with a larger share of PEI relative to FDI. This result points to a collateral benefit of reserves that has been neglected so far. Reserves may contribute to develop domestic financial markets and facilitate domestic firms' access to foreign portfolio equity financing. In addition, this paper finds a strong negative effect of the global financial crisis beginning in 2008 on the share of PEI, which confirms the hypothesis that PEI is more crisis‐dependent than FDI.