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.     

Stock Market‐Induced Currency Crises—A New Type of Twins

This paper explores the link between currency crises and the stock market in emerging economies. By integrating foreign stock market investors in a currency crisis model, we reveal a new fundamental inconsistency as a potential crisis trigger: since emerging economies' stock markets often have high returns, whereas central bank reserves grow slowly or decline, the amount of reserves foreign investors can deplete when selling their stocks and repatriating the proceeds grows over time and is considerably higher than funds that have been invested in the stock market. Capital withdrawals of foreign stock market investors can trigger currency crises by depleting central bank reserves, particularly in successful countries with booming stock markets and large foreign investment.     

The Vulnerability of ASEAN+3 Countries to International Financial Crises

This article focuses on the reaction of the Association of Southeast Asian Nations (ASEAN) economies to international financial shocks. The crises in emerging markets at the end of the last century underlined the significant vulnerability of the emerging ASEAN economies to international financial fluctuations and a lack of sustainability in their exchange rate regime. A structural VAR model is used to analyze the efficiency of the measures adopted by these countries after this episode of crisis in order to protect their economies against speculative attacks. The results reveal that the impact of the recent subprime crisis on emerging ASEAN countries is less significant than that observed in industrialized ones.     

Reserve accumulation and financial crises: From individual protection to systemic risk

This paper provides a new perspective on the relationship between countries׳ international reserve holdings and financial crises: while the “local” view holds that reserves may prevent domestic crises, it overlooks that the accumulation of reserves relaxes the financing constraint of the reserve currency country and may cause a financial crisis in the centre, which is transmitted globally. According to this “global” view reserve accumulation might destabilize the international financial system. Since the crisis affects all countries alike, the accumulation of reserves imposes a negative externality on non-accumulating countries.We integrate this idea in a theoretical model of the optimal amount of reserves and illustrate the gap between local and global optimality: the consideration of systemic risk lowers the demand for reserves. Moreover, if a supranational authority determines the optimal level of reserves, it internalizes the negative externality and accumulates fewer reserves. A macroprudential tax on reserve hoardings might implement the socially optimal solution. Our calibration analysis shows that these considerations are economically significant: they lower the optimal amount of reserves in the benchmark case by 45%.     

Sudden stops, banking crises and investment collapses in emerging markets

We evaluate whether financial openness leaves emerging market economies vulnerable to the adverse effects of capital reversals (“sudden stops”) on domestic investment. We investigate this claim in a broad sample of emerging markets during the period 1976–2002. If the banking sector does not experience a systemic crisis, sudden stop events fail to have a significant impact on investment. Bank crises, on the other hand, have a significant negative effect on investment even in the absence of a contemporaneous sudden stop crisis. We also find that openness to capital flows worsens the adverse impact of banking crises on investment. Our results provide statistical support for the policy view that a strong banking sector which can withstand the negative fallout of capital flight is essential for countries that open their economies to international financial flows.     

The illusive quest: Do international capital controls contribute to currency stability?

We investigate the effectiveness of capital controls in insulating economies from currency crises, focusing in particular on both direct and indirect effects of capital controls and how these relationships may have changed over time in response to global financial liberalization and the greater mobility of international capital. We predict the likelihood of currency crises using standard macroeconomic variables and a probit equation estimation methodology with random effects. We employ a comprehensive panel data set comprised of 69 emerging market and developing economies over 1975–2004. Both standard and duration-adjusted measures of capital control intensity (allowing controls to “depreciate” over time) suggest that capital controls have not effectively insulated economies from currency crises at any time during our sample period. Maintaining real GDP growth and limiting real overvaluation are critical factors preventing currency crises, not capital controls. However, the presence of capital controls greatly increases the sensitivity of currency crises to changes in real GDP growth and real exchange rate overvaluation, making countries more vulnerable to changes in fundamentals. Our model suggests that emerging markets weathered the 2007–2008 crisis relatively well because of strong output growth and exchange rate flexibility that limited overvaluation of their currencies.     

International Financial Contagion: Why are Eastern Europe's banks not failing when everybody else's are?

While the Asian financial crisis spread to Russia and Brazil, the transition economies in Central and Eastern Europe (CEECs) are largely unaffected by international financial contagion. This is the more surprising considering that most economies have experienced severe banking sector problems in the past, that large bad loan ratios are still prevalent, that banking regulation and supervision are only slowly improving, and that stabilizing policies have slowly been eliminated. What insulated the CEECs from the recent wave of financial instability? To consider the counterfactual, we first provide a framework that links banking crises to financial deregulation. We then focus on a number of macro- and microeconomic factors, using data compiled from the IMF's International Financial Statistics, from the World Bank's World Debt Tables, and from the BIS's Consolidated International Banking Statistics. We first compare past experiences in CEECs with those in other emerging economies as a cross-sectional reference point. We then consider whether the situation in CEECs has changed since the last banking sector problems, in order to establish a reference point across time. Our results indicate that the factors leading up to past banking crises are generally different in CEECs from those in other emerging economies. However, in recent years, the characteristics of CEECs have become more similar to those of other emerging economies.     

Managing Financial Integration and Capital Mobility—Policy Lessons from the Past Two Decades

Emerging market experience over the past two decades has revealed the tenuous links between external financial integration and faster growth, and the proclivity of such integration to fuel costly crises. Emerging markets learned, converging to the middle ground of the macroeconomic trilemma. Following their crises of 1997–2001, emerging markets added financial stability as a goal, self‐insured by building up international reserves, and adopted a public finance approach to financial integration. The global crisis of 2008–09 illustrated that the advanced economies “overshot” the optimal degree of financial deregulation, while the resilience of the emerging markets validated their public finance approach to financial integration.     

Global banking,global crises? The role of the bank balance-sheet channel for the transmission of financial crises

We examine whether shocks to leveraged creditors with cross border holdings have an incidence on debtor countries׳ risk of suffering financial turmoil. We construct a new proxy of shocks to international banks׳ balance-sheets using credit ratings and the structure of their international assets. This allows us investigating the effect of (foreign) bank balance-sheet shocks on domestic financial turmoil in a large sample of 146 developed and emerging economies from 1984 to 2011. Our proxies of shocks towards bank balance-sheets are strong predictors of systemic banking crises in their debtor countries. Confirming these results, bilateral bank flows significantly decrease when creditor banks׳ assets are hit by negative shocks, as measured by credit rating downgrades from third-party countries. Short-term liabilities towards global banks appear to increase roll-over and funding risks, thereby amplifying the impact of shocks to foreign lenders’ balance-sheets. Domestic banking sectors vulnerabilities, such as illiquid assets and a low deposit-asset ratio, are found to increase crisis contagion risk. In contrast, a high level of global liquidity attenuates the transmission of shocks to international banks׳ assets to debtor countries.     

新兴经济体与后金融危机时代IMF改革

全球金融危机爆发之后,国际货币基金组织不成功的援助措施使各国要求加快其改革进程。同时国际金融体系也在危机后重组,新兴经济体作为新兴力量在世界经济格局中崛起。新兴经济体成为一支独立的联合力量,并在IMF改革中提出自身的主张,要求获得更多话语权。新兴经济体由于其强大的经济实力和发展中国家的支持,促使发达国家依赖其进行IMF改革。同时,新兴经济体在参与IMF改革中也面临发达国家的压力,综合实力对比与金砖国家之间关系均影响着新兴经济体的合作。     

International reserves and swap lines: Substitutes or complements?

Developing Asia experienced a sharp surge in foreign currency reserves prior to the 2008–9 crisis. The global crisis has been associated with an unprecedented rise of swap agreements between central banks of larger economies and their counterparts in smaller economies. We explore whether such swap lines can reduce the need for reserve accumulation. The evidence suggests that there is only a limited scope for swaps to substitute for reserves. The selectivity of the swap lines indicates that only countries with significant trade and financial linkages can expect access to such ad hoc arrangements, on a case by case basis. Moral hazard concerns suggest that the applicability of these arrangements will remain limited. However, deepening swap agreements and regional reserve pooling arrangements may weaken the precautionary motive for reserve accumulation.     

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.     

Empirical Indicators of Currency Crises in East Asia

The paper is concerned with identifying useful indicators of the probability of currency crises in Indonesia, Malaysia, the Philippines, South Korea and Thailand over a period of 22 years, where a currency crisis is defined as a large and infrequent devaluation of a local currency. The leading crisis indicators include international and domestic factors; but they are dominated by the leading indicators from the financial sector, such as the ratio of short-term debt to foreign reserves, the ratio of M2 to foreign reserves, and the indicator representing a regional contagion effect. This result is interpreted as pointing to external illiquidity together with adverse shifts in the market sentiment as the likely catalyst for the 1997–98 East Asia crisis.     

The 2014–15 Financial Crisis in Russia and the Foundations of Weak Monetary Power Autonomy in the International Political Economy

ABSTRACT

This article contributes to international political economy debates about the monetary power autonomy (MPA) of emerging market and developing countries (EMDs). The 2014–15 Russian financial crisis is used as a case study to explore why an accumulation of large international reserves does not provide protection against currency crises and macroeconomic adjustments in EMDs. The analysis centres on the interplay between two dimensions of MPA: the Power to Delay and the Power to Deflect adjustment costs. Two structural factors condition Russia’s low MPA. First, the country’s subordinated integration in global financial markets increases its financial vulnerability. The composition of external assets and liabilities, combined with cross-border capital flows, restrict the use of international reserves to delay currency crises. Second, the choice of a particular macroeconomic policy regime embraced the financialisation of the – mainly state-owned – Russian banking sector, thus making it difficult to transform liquidity inflows into credits for enterprises. Russia’s main comparative advantage, hydrocarbon export revenues, is not exploited. The type of economy created due to the post-Communist transition means that provided ‘excessive’ liquidity remains in the financial system and is channelled into currency arbitrage. This factor increases exchange rate vulnerability and undermines Russia’s MPA.     

后危机时期国际金融格局的变动及其对美国经济的影响

2008年金融危机给世界经济带来了重大的影响,国际金融格局也发生了显著变化。本文主要分析了国际汇率体系、国际收支和国际储备体系、国别经济政策与国际间经济政策协调的变化。在后危机时期,美国经济也受国际金融格局变化的影响,包括美元中心地位的问题、“中心一外围”模式可持续性的问题和美国的国际经济领导权问题。本文得出的主要结论是：国际几种主要货币汇率波动增大,国际汇率体系弹性增大,国际收支总体失衡程度下降,美元为主的国际储备体系呈多元化趋势,先进经济体与新兴发展经济体的经济协调在加强,美元的霸权地位面临挑战,美国在国际分工中的中心地位在下降,美国在国际经济的主导地位也在逐渐下降,新兴经济体获得更多的话语权。     

Currency crises and the stock market: empirical evidence for another type of twin crisis

We explore the dependency between currency crises and the stock market in emerging economies. Our focus is two-fold. First, the risk of a currency crisis rises as the foreign stake in the domestic stock market increases. Successful economies with high capital flows into their booming stock markets especially are prone to stock market-induced currency crises. Second, we apply the dividend growth model to show that stock markets crash in the run-up to a currency crisis. This new type of twin crisis is empirically tested by employing a logit framework using quarterly data for 33 emerging economies for 1994Q1–2007Q4.     

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.     

Financial Globalization,Financial Crises,and the External Portfolio Structure of Emerging Markets*

We study the transitional dynamics of financial integration in emerging economies using a two‐sector model with a collateral constraint on external debt and trading costs incurred by foreign investors. The probability of a financial crisis displays overshooting; it rises sharply initially and then falls sharply, but remains non‐zero in the long run. While equity holdings fall permanently, bond holdings initially fall, but rise after the probability of a crisis peaks. Conversely, asset returns and asset prices first rise and then fall. These results are in line with the post‐globalization dynamics observed in emerging markets, and the higher frequency of crises that they display.     

A few observations on financial liberalization and financial instability

Recent studies have conjectured that there may be a link between financial liberalization (FL) and financial instability in emerging economies. Most of these studies, however, do not investigate whether emerging economies are, in fact, becoming structurally more vulnerable to currency and banking crises. In this paper, I argue that emerging economies are becoming more susceptible to both currency and banking crises after FL. Using data for 27 emerging economies—excluding transition economies—from 1973 to the present, a univariate analysis indicates that the likelihood of currency crises may increase with stronger reactions to financial variables than to real or external trade variables. Similarly, for banking crises, interest rate, exchange rate, maturity, and default may increase, while simultaneously the support structure of the government seems to decline.     

Withstanding financial crises: would trade partners help or hurt?

This article provides new empirical evidence on the losses of real activity caused by various financial shocks. Spillover effects due to foreign trade linkages deserve special attention. To this end, we estimate a modify auto-regressive process and a Seemingly Unrelated Regression Equations estimator is used to account for the dependency of one’s country growth on its trade-weighted partners growth. We run estimations on a set of currency collapses, banking crises and sovereign defaults in 49 advanced and developing countries from 1978 to 2011. The trade-weighted foreign demand effect mitigated the economic downturn following a banking or a sovereign debt crisis in all countries, while only the advanced ones benefited from it after a currency collapse. Trade-based spillover effects make banking crises more costly in the developing countries, in those that liberalize their financial account. It contrasts with what is observed during currency or sovereign debt crises.