The Foreign Exchange Reserves Buildup: Business as Usual?

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The Foreign Exchange Reserves Buildup Business
as Usual?

• Charles Wyplosz
• Graduate Institute of International Economics
• and CEPR
• Workshop on Debt, Finance and Emerging Issues
• in Financial Integration, 6-7 March 2007

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The issue
Excessive?
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Need to answer two questions

• Measurement
• Criteria
• Both related to motive

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Measurement

• Nominal reserve stocks
• Usual scale variables
• GDP
• Trade (imports, exports)

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Measurement

• Nominal reserve stocks
• Usual scale variables
• GDP
• Trade (imports, exports)
• Popular rules
• 3 months of imports
• Stock of short-term external liabilities
• Greenspan-Guidotti-Fischer rule

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A different picture
Excessive?
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The impact of financial globalization
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More details Who does it?
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More details Who does it and why?
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And some outliers
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Excessive?

• The motives approach
• The cost-benefit approach

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Motives

• Self-insurance
• Shifting risks
• from trade balance to capital account
• from 3 months of imports to Greenspan-Guidotti-Fis
  cher rule
• Mercantilism
• Variant 1 Export-led growth strategy
• Variant 2 Keep savings home
• Variant 3 Hold reserves for the sake of it
• Variant 4 Directed credit

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Testing motives

• Aizenman and Lee (2006)
• Strong effect of variables related to
  self-insurance
• Capital account liberalization
• Crisis dummies
• Some effect of variables related to mercantlism,
  but much weaker
• Undervaluation
• Export growth

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Testing motives

• Aizenman and Lee (2006)
• Jeanne and Rancière (2006)
• Model of self-insurance
• Reserve build-up well explained
• But some outliers in South-East Asia

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Testing motives

• Aizenman and Lee (2006)
• Jeanne and Rancière (2006)
• Official and unofficial statements
• Conclusion self-insurance and fear of IMF

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Costs and benefits

• Costs
• Direct costs
• Rodrik (2006) 1 of GDP for reserves 30 of GDP
• Opportunity costs
• Better returns at home (private and public)
• The case of China

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Costs and benefits

• Costs
• Benefits
• Export-led growth
• Self-insurance

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Export-led growth

• Apparently successful, so a benefit?
• Only if systematic undervaluation works
• No evidence that it does
• No theory
• Nominal vs. real exchange rate
• Strong foreign demand inflation
• Unless domestic demand is weak
• High saving is the key success factor
• But then what to do with the savings?
• Invest at home or abroad

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Self-insurance

• Currency crises can be very expensive
• A good reason to buy insurance
• Do high reserve stocks provide insurance?
• Not really an insurance
• Reduce the odds of crisis
• Unlikely to eliminate the threat
• False sense of immunity
• Could discourage reforms
• Could encourage imprudent policies

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Wrap-up

• Limited evidence of excessive accumulation
• Some prominent exceptions
• Little evidence of mercantilist motive
• Mostly self insurance
• Recent build-up is business as usual
• What has been unusual is financial gloablization