Central bank foreign reserve accumulation: Motives and implications

Transcription

1 Central bank foreign reserve accumulation: Motives and implications Ramon Moreno 26 April

2 Stock of foreign currency reserves At year-end, as a percentage of world GDP Industrial economies Japan Developing countries China

3 Annual changes in foreign currency reserves In billions of US dollars China Japan Emerging Asia Latin America CEE Rest of the world

4 Distribution of global reserves End-2006, in billions of US dollars and as a percentage of total Rest of the world, 962, 19% China, 1'066, 22% CEE, 477, 9% Latin America, 271, 5% Emerging Asia, 647, 13% Taiwan, 266, 5% Japan, 875, 17% Korea, 238, 5% Euro area, 184, 4% United States, 41, 1% 4

5 The issues Sources of reserves Reasons for intervention Costs and consequences of reserve accumulation 5

6 Balance of Payments 1 Current account balance 2 Net capital inflows 3 Change in reserves Asia China India Korea Malaysia Singapore Thailand Latin America Brazil Central Europe Russia Turkey Middle East Total Cumulative sum for the period. Billions of US dollars. Aggregates are the sum of the countries. 2 IMF April 2007 World Economic Outlook forecasts. 2 Financial account, nie. Except for Venezuela, 2006 figures are calculated as the current account balance minus the change in foreign exchange reserves. 4.Foreign exchange 5 Countries below plus Hong Kong SAR, Indonesia, the Philippines and Taiwan (China). 6 Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. 7 Czech Republic, Hungary and Poland. 8 Kuwait, Libya, Oman, Quatar and Saudi Arabia. Sources: IMF, Balance of Payments Statistics; IMF April 2007 World Economic Outlook; Datastream 6

7 FDI is an important source in some regions 2006, in billions of US dollars Other investment 600 Portfolio investment 500 Direct investment Current account balance Emerging Asia Latin America CEE

8 CA surpluses driving reserve accumulation: implications Reduced vulnerability: less chance of sudden stop in capital flows Foreign currency surrender requirements for exporters ensure current account direct source of foreign currency inflows and appreciation pressures. Controls on capital inflows might not curb appreciation pressures. Less investment, less consumption and perhaps less growth Average growth fell 34%-45% in Indonesia, Thailand and Malaysia between (large current account deficits) and (current account surpluses) 8

9 CA surpluses driving reserve accumulation: Puzzle Current account alone determining exchange rate fluctuations seems implausible if capital flows small how do exchange rate appreciation pressures still happen? Portfolio theory suggests no flows necessary but implicitly assumes you can buy/sell any security. Investable set much smaller in emerging market economies Gross capital flows imply some accumulated positions in emerging market assets by foreigners Some position-taking or transactions (eg derivatives) might take place outside emerging market jurisdictions, but still affect exchange rates 9

10 The issues Sources of reserves Reasons for intervention Changes in reserves imply intervention precautionary reserves exchange rate volatility currency mismatches Influence the exchange rate level key determinants Costs and consequences of reserve accumulation 10

11 Precautionary reserves The reserves are primarily there in case we are called upon to use them; managing them for added return is merely what we do until they are needed - Bank of England senior official as quoted by John Nugee, State Street Global Advisors in Central Banking, vol XIII.1, August

12 Determining precautionary reserves three rules of thumb: traditional rule: 3 to 6 months of imports Guidotti rule: one-year cover for short-term foreign currency debt Calvo rule: ratio to broad money (M2) their usefulness is related to the availability of external financing and exchange rate regime following these rules is supposed to prevent crises 12

13 Foreign exchange reserves Outstanding year-end position, USD bn Imports As a percentage of: Short-term external debt 1 Broad money Latin America Asia, large Southeast Asia Central Europe Emerging markets Memo: Australia Japan Sweden Short-term external debt defined as short-term liabilities to BIS reporting banks: consolidated cross-border claims to all BIS reporting banks on countries outside the reporting area with a maturity up to and including one year plus international debt securities outstanding wit a maturity of up to one year. 2 Sum or average of Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. 3 Sum or average of China, India, Korea and Taiwan (China). 4 Sum or average of Indonesia, Malaysia, the Philippines and Thailand. 5 Sum or average of the Czech Republic, Hungary and Poland. 6 Sum or average of the above plus Russia, Turkey and South Africa. Sources: IMF; national data; BIS. 13

14 Foreign exchange reserves (details) Outstanding yearend position, USD bn Imports As a percentage of: Short-term external debt 1 Broad money Asia, large China India Korea Taiwan (China) Southeast Asia Indonesia Malaysia Philippines Thailand Short-term external debt defined as short-term liabilities to BIS reporting banks: consolidated cross-border claims to all BIS reporting banks on countries outside the reporting area with a maturity up to and including one year plus international debt securities outstanding wit a maturity of up to one year. 2 Sum or average of the economies shown. Sources: IMF; national data; BIS. 14

15 Foreign exchange reserves (details) Outstanding yearend position, USD bn Imports As a percentage of: Short-term external debt 1 Broad money Central Europe Czech Republic Hungary Poland Russia Turkey South Africa Emerging markets Memo: Australia Japan Sweden Short-term external debt defined as short-term liabilities to BIS reporting banks: consolidated cross-border claims to all BIS reporting banks on countries outside the reporting area with a maturity up to and including one year plus international debt securities outstanding wit a maturity of up to one year. 2 Sum or average of the economies shown. Sources: IMF; national data; BIS. 15

16 Foreign exchange reserves (details) Outstanding yearend position, USD bn Imports As a percentage of: Short-term external debt 1 Broad money Latin America Argentina Brazil Chile Colombia Mexico Peru Venezuela Short-term external debt defined as short-term liabilities to BIS reporting banks: consolidated cross-border claims to all BIS reporting banks on countries outside the reporting area with a maturity up to and including one year plus international debt securities outstanding wit a maturity of up to one year. 2 Sum or average of the economies shown. Sources: IMF; national data; BIS. 16

17 Why intervene? Smooth volatility Symmetric intervention excessive short run volatility might be destabilizing and affect market liquidity Bank Indonesia has intervened when volatility exceeded average annual volatility Czech National Bank does not intervene to counter short-run volatility lets the market take care of it 17

18 Why intervene? Prevent overshooting resist rapid movements ( lean against the wind ) can facilitate the development of foreign exchange markets by reducing uncertainty but government role could also reduce incentives to hedge (apparent view of Chile, Israel, Mexico) respond to perceived misalignments exchange rate movements can persist in one direction for extended periods CNB responds to extreme fluctuations around a long run trend Banco Central de Chile worries that excessive movements are incompatible with its inflation target 18

19 Why intervene? Support market functioning maintain an orderly, liquid forex market a loss of market liquidity can lead to a downward spiral in the exchange rate Brazil in 2002 issued exchange-rate linked debt in an effort to maintain two-way markets (provide hedging instruments) further reading Foreign Exchange Market Intervention in Emerging Markets, BIS Papers no 24, 19

20 Why intervene? Currency mismatches if foreign-currency liabilities exceed foreign-currency assets, a currency depreciation can have serious economic repercussions borrowing firms might go bankrupt government might face higher debt payments result can be a crisis and severe output contraction reserves can guard against the mismatch problem in a consolidated balance sheet for the whole economy, reserves could offset foreign currency debt raises issues of risk management on the part of borrowers 20

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22 Why intervene? Target exchange rate level to achieve export-led growth promote exports by preventing appreciation buy reserves to prevent appreciation export-led growth might stimulate foreign investment if this results in balance of payments surpluses, the central bank must invest its reserves with little consideration for risk/return distorts domestic prices to favour traded-goods production assumes greater positive externalities from the growth of tradedgoods production, eg technology transfer 22

23 Reviving Bretton Woods Dooley, Michael P., David Folkerts-Landau and Peter Garber "The Revised Bretton Woods System," International Journal of Finance and Economics, v9(4,oct), Three types of countries Center is United States Trade account countries mainly Asia Capital account countries Europe and Latin America Center runs current account deficits Trade account countries intervene to prevent exchange rate appreciation (notice focus on exchange rate level and not just volatility) and accumulate reserves Predict trade account countries see less appreciation, more reserves, more exports, more FDI 23

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28 The issues Sources of reserves Reasons for accumulating reserves Costs and consequences of reserve accumulation sterilised intervention financial costs macroeconomic consequences 28

29 Reserve accumulation and sterilisation purchase or sale of foreign assets must be offset by changes in other parts of the balance sheet central bank seeking to resist appreciation must choose how to fund its purchases of foreign assets ( FA > 0) unsterilised intervention increase the money supply ( MB > 0) control the exchange rate but lose control of the money supply sterilised intervention sell domestic assets ( DA < 0) or issue central bank bonds ( CB > 0) Research on developed coutnries: control the money supply but no influence on the exchange rate. Reality for EMEs: may have an impact if forex markets small or illiquid and scale of intervention is large. 29

30 Financial cost of reserves reserves are low-yielding foreign assets if reserves are funded with foreign liabilities then a simple measure of the cost is the sovereign bond spread reserves might help enhance credit ratings and thus reduce sovereign spreads, thereby partially offsetting this cost if reserves are funded with domestic liabilities, the cost is the differential between domestic and foreign yields 30

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33 Financial cost of reserves Median estimate for 2004, as a percentage of GDP Asia Latin Central Pacific America Europe Opportunity cost Foreign returns Lower spread Revaluation gains = Overall costs Source: Hauner (2005): A fiscal price tag for international reserves, IMF Working Paper no WP/05/81. 33

34 Financial cost of reserves: do central bank profitability and capital matter? yes: central bank should maintain sufficient capital to absorb any losses from fulfilling its responsibilities losses undermine credibility and independence Mexico has taken steps to limit the growth of foreign reserves because of concerns about carrying costs no: central bank can operate even when bankrupt central bank is special it is not a profit maximising entity and is often called upon to implement policies that result in losses Chile functioned for years with losses and negative capital and still had very successful monetary policy 34

35 Macroeconomic consequences of reserves impossible trinity (Mundell-Fleming model) open capital account fixed exchange rate independent monetary policy if intervention is not sterilised equivalent to an easing of monetary policy if output is near capacity, accommodative policy may lead to consumer price inflation or an asset price boom 35

36 Macroeconomic consequences of reserves if intervention is sterilised aggravate financial sector imbalances expectations of future appreciation might attract short-term capital inflows and encourage unhedged foreign-currency borrowing issuance of short-term sterilisation bonds improves the liquidity position of banks and so might encourage lending distort financial intermediation greater use of non-market instruments, eg reserve requirements, direct credit controls hinder the development of a corporate bond market alter the behaviour of banks Eg Malaysia: 1994 imposed capital controls in response to surging capital inflows 36

37 Central bank financing gap 1 As a percentage of GDP As a percentage of public debt securities outstanding China India Korea Russia Taiwan (China) Foreign reserves (valued in local currency) less currency in circulation. Source: Mohanty and Turner (2006). 37

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39 40 Median Median Foreign exchange reserves Net foreign assets Base money Credit to the private sector Inflation Real Interest rate Equity prices in local currency 39

40 Summary Sources of foreign reserves current account balance, net capital flows Reasons for accumulating reserves precautionary balances, exchange rate volatility, currency mismatches, exchange rate target Costs and consequences of accumulating reserves carrying costs, inflationary consequences, financial system distortions 40