International Reserves and Fiscal Policy in Developing Countries

This paper investigates empirically the relationship between the pattern of fiscal policy and the demand for international reserves in developing countries, and how this relationship is associated with political risk and conditional access to global capital markets. It finds evidence that for developing countries with low political risk, countercyclical (procyclical) fiscal policies are associated with higher (lower) international reserve holdings in economic downturns. The relationship is stronger when the countries with low political risk rely heavily on external financing. For developing countries with high political risk, the link between reserves holdings and fiscal policy pattern is not clear-cut.