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
The issue
Reserves (US $ bn.)
4000
3500
3000
Excessive?
2500
2000
World
1500
1000
500
Emerging
0
1970
1975
1980
1985
1990
1995
2000
2005
Need to answer two questions
• Measurement
• Criteria
• Both related to motive
Measurement
• Nominal reserve stocks
• Usual scale variables
 GDP
World Foreign Exchange Reserves
 Trade (imports, exports)
0.40
0.10
Reserves/GDP
Reserves/trade
0.35
0.08
0.30
0.06
0.25
0.04
0.20
0.02
0.15
1980
1985
1990
1995
2000
2005
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
A different picture
Reserves/External liabilities
(unweighted averages)
0.6
0.5
World
Excessive?
0.4
Emerging
0.3
0.2
0.1
1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003
The impact of financial globalization
External liabilities (US $ mn.)
350000
300000
250000
200000
World
150000
100000
Emerging
50000
0
1970
1974
1978
1982
1986
1990
1994
1998
2002
More details: Who does it?
Reserves/External liabilities
Reserves/External liabilities
0.8
0.8
South-East Asia
0.6
0.6
Non-EU Europe
Oil exporters
0.4
0.4
Africa
0.2
0.2
Emerging
Latin America
0
0
1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003
1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003
More details: Who does it and why?
External liabilities
350000
300000
250000
South East Asia
200000
150000
100000
Oil exporters
50000
Latin America
Africa
0
1970 1974 1978 1982 1986 1990 1994 1998 2002
And some outliers
Reserves/External Liabilities
1.4
1.2
Greenspan-Guidotti-Fischer
1
0.8
0.6
China
0.4
0.2
Korea
0
1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003
Excessive?
• The motives approach
• The cost-benefit approach
Motives
• Self-insurance
 Shifting risks
• from trade balance to capital account
• from 3 months of imports to Greenspan-GuidottiFischer 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
Testing motives
• Aizenman and Lee (2006)
 Strong effect of variables related to selfinsurance
• Capital account liberalization
• Crisis dummies
 Some effect of variables related to
mercantlism, but much weaker
• Undervaluation
• Export growth
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
Testing motives
• Aizenman and Lee (2006)
• Jeanne and Rancière (2006)
• Official and unofficial statements
• Conclusion: self-insurance and fear of IMF
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
Costs and benefits
• Costs
• Benefits
 Export-led growth
 Self-insurance
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
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
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