Foreign Reserves Accumulation by Some Developing Countries - Essay Example

FOREIGN RESERVES ACCUMULATION By Student’s Name Code + Name of Course Professor/Tutor Institution City/State Date Foreign Reserves Accumulation by Some Developing Countries Question 10: Why are some emerging countries accumulating so much foreign reserves? Introduction Foreign-exchange reserves take a critical part in macroeconomic management. They are said to provide security during periods of financial economic crisis, and for many emerging economies, it is an approach to pegging the nominal rate of exchange. The reserves also lend a means to managing windfalls from sudden capital surges or from commodity exports. Recently, in different countries, particularly the developing market economies, the public sector has accumulated considerable financial assets across the border, majorly as official foreign-exchange reserves (Aizenman, Jinjarak & Park 2011, pg. 6). The question asked in this paper is why some developing economies are increasingly accumulating foreign reserves. This question is significant because the remarkable speed of reserve accumulation has turned into an important matter on the global policy agenda. In fact, the matter has been analyzed from different perspectives, comprising the discussion on high net savings within the oil exporting states and the Asian economies, reserve accumulation sustainability, the current U.S. currency deficit accounts among other issues (Dominguez, Hashimoto & Ito 2012, pg. 390). The accumulation of foreign reserves cause major changes in balance sheet figures, which render critical macro-economic implications. Foreign exchange reserves dominate the asset standing of the balance sheets of emerging economies especially China. These reserves are kept in government bonds provided by the main reserve currency regions (U.K., Japan, U.S., and Euro Zone). The latest global financial crunch heightened the incentives for foreign reserves accumulation for self-insurance aims thus ensuring the maintenance of the foreign demand for these emerging economy bonds (Morrison & Labonte 2011, pg. 507). These depend on both the way the linked threat exposures are handled and the manner in which the intervention is financed. Different other potential problems comprise the high intervention costs, unsustainable rises in asset and credit prices, and a progressively disorganized financial system. Different studies provide data on the implications of the supporting of the continued as well as considerable amassing of reserves for the private sectors’ balancing sheet and the entire system of banking (Pontines & Rajan 2011, pg. 258). The response to the question of foreign exchange reserves comprises carrying out a critical review of the voluminous literatures that talk about the subject. Most of the data used in these studies is adapted from the WB and the International Monetary Fund. Data In addressing the question of why some emerging economies are accumulating substantial amounts of foreign exchange reserves, this study found that the empirical and theoretical and empirical literature examining the issue of reserve adequacy was quite scanty until lately when a rising series of researches endeavored to model and estimate empirically optimum foreign reserve levels. Generally, the latest swell of reserves by emerging economies and especially emerging Asia has motivated the latest upsurge of this literature. The Studies investigating the region’s optimum reserves comprise Morrison & Labonte, 2011; Aizenman, Jinjarak, & Park, 2011; Dhar 2012; Dominguez, Hashimoto & Ito, 2012; Kim, Dabla-Norris & Shirono, 2011; and Bussière, Cheng, Chinn & Lisack, 2015. These studies examine the main macroeconomic determinants revolving around the foreign reserves accumulation issue. Thus, this study relies on the descriptive statistics provided on in these literatures. The IMF provides more data. Noteworthy, the data comprising tables and graphs, which is documented by the IMF in its newest updated Currency Foreign-Exchange Reserves Structure database (International Monetary Fund 2011). The overall evidence in the emerging literature approves the story documented on reserve adequacy, that the present reserve increase in the Asia region has exceeded its ideal range although the readings vary significantly on the extent of the overextending. Indeed, the researches collectively discover the area’s reserves starting to surpass their optimum ranges about 2001, 2002, and flattening out towards 2014. Articles by Dadush and Stancil (2011) and Bracke & Fidora (2012) provides more information on the levels of reserves in the twenty biggest emerging economy reserve holders including data about the global liquidity glut. In the remaining parts of this paper, data is updated until 2015 and 2016. Analysis This part constitutes an analysis of the mystery of the accumulation of reserves in the last decade. On an international level, reserves have risen starkly in the last ten years, with the upsurge gaining momentum until 2014 with most of the rise happening in emergent economies. In 1995, foreign exchange rose from 1.2 trillion $ to 4 trillion $ (in 2005). Eight countries within Asia are amongst the leading ten biggest reserves holders: Japan, China, Taiwan (a province in China), Korea, Hong Kong, India, Singapore, and Malaysia. China’s balance of payments has increased considerably through the years and so has its foreign exchange reserves, which is often considered the highest in the region. Figure 1: China’s BOP. The BOP has resulted in this: In general, the foreign exchange reserves of emerging economies reached a peak in 2014. From an amount of $ 1.8 trillion USD in 2000, international foreign reserves peaked at $2 trillion USD by mid-2014. Fig 2: Global Currency Composition of Foreign Exchange Reserves From: IMF The foreign exchange reserves accumulation by emerging market economies has caused upward and downward stages of the tide. Even though China’s and other non-developed economies in Asia, growth reserves represented more than half of the reserves expansion in the new millennium. Other emerging economies have witnessed substantial rises similarly. Fig. 3: FER changes of developing economies (% of GDP). Gross Global Reserves, (2005-2015) Figure 1: Asian Foreign Exchange Reserves Japan was the global biggest holder of reserves and the only emerging economy among the leading reserve-stocking states to aggressively augment its reserves. Changes in capital flows to China have been remarkable. Thus, the country has also been augmenting its reserves substantially. Reserves stood at 769 billion USD in 2005. The interaction of a huge surplus in current and capital account of the private sector rose from 2001 onwards making Chinese authorities to pile dollar reserves from $ 170 billion USD in 2000 to $ 4 trillion USD in August 2014. Oil-exporting states in the Middle East and Africa also amplified their reserves stocks in keeping with the rise in oil prices. In Africa reserves rose from 39 billion USD by the end of 1995 (January) to 147 billion USD by June 2005. Fig. 4: Foreign exchange reserves of China and Japan (2000-2009) The data demonstrated above leads us to the question as to why these emerging are accumulating their levels of foreign reserves. Noteworthy, the measures introduced by the IMF generate hugely differing estimations of reserve adequacy. Thus, emerging economies presently keep between 1 and 4 trillion $ in superfluous reserves. Beginning 2000 going to 2011, the foreign exchange reserves nominal stock in emerging economies rose from about 760 billion USD (11 per cent of GDP) to about 6.3 trillion USD (29 per cent of GDP), an astounding rise in comparison to an increase from 1.3 trillion USD to 3.4 trillion USD in OECD states (Dadush and Stancil 2011, pg. 274). Fig. 2: Levels of reserves in the twenty biggest emerging states (billions of $) This study responds to the question as to why the emerging economies started the rapid accumulation of their reserves in the last decade. The main essential drivers of reserve accumulation are the need to self-insure against financial crunches and the pursuit (during certain periods for instance after an economic turmoil), of export-driven development by different Asian countries, motivated by exchange rates (Kim, Dabla-Norris, & Shirono 2011, pg. 12). The other driver comprises the collective outcome of several attributes linked to the economic structure of various EME’s (Dhar 2012, pg. 97). A customary motivation for leading banks to amass global reserves is their desire of foreign currency to overcome possible unstable currency markets. The start of deficits in balance-of-payments has made countries to adopt various alternatives i.e., they can undertake expense-swapping policies for instance taking a lower proportion of exchange or putting up import quotas and/or tariffs. They could also enforce expense-minimizing laws, effectively decreasing financial development. They could also engage in laws that encourage exportation. Thus, this assessment has found that developing market economies may wish to amass reserves to counter turmoil in currency markets and that optimum reserve stocks might be comparatively high, provided the rise in mobility of capital and the faults of local system of banking among other issues. However, in the previous years, the buildup of reserves globally has demonstrated somewhat rare trends. In specific, traditional “reserve adequacy” indicators demonstrate that the held global reserves is considerably superfluous in several emerging economies, especially within Asia. This brings to fore the likelihood that different other elements could be motivating the fast buildup of reserves (Bracke and Fidora 2012, pg. 186). After its financial crunch, savings levels in emerging Asia increased progressively from approximately 32 % of GDP (in the ‘90s) to 44 % (in 2009); investment, which degenerated in the course of the crunch was sluggish to return, moving to 42% of Gross Domestic Product. This suggests a huge excess in current account. Increasing oil and commodity values also took a critical objective in this; the oil exporters’ reserves peaking 1.5 trillion $ (in 2010) (Bracke and Fidora 2012, pg. 188). A superficial assessment of this evidence shows that, while these attributes were clearly critical, they only form a part of the entire story. Guidelines in reserve currency economies assisted in creating a “global liquidity glut,” which culminated in accumulation of the reserves in numerous developing markets. Although the narrative differs from the “global savings excess” model that proposes that risen stocks in developing economies fueled lowered interest rates in the long-term on developed economies, the explanations above are moderately matching. From about 2000, America, the United Kingdom, and marginal Europe started an expenditure indulgence, which raised their current account shortfall from below 0.5 % of the 1990s global GDP to below 2% between 2008 and 2005. In America, low interests, tax reductions, unfinanced military expense, and a real-estate up rise gradually broadened the account deficit (from -1.7 to ---6.2 Gross Domestic Product % (in 2006) (Bracke and Fidora 2012, pg. 190). Meanwhile, the cut in interest rate attributable to the conception of the euro introduced an intense rise in demand in (marginal) Europe culminating in a mean current account shortfall in Portugal, Spain, Italy, Greece, and Ireland to broaden intensely. Meanwhile, pushed by developments in emerging economies and reduced interest rates globally, private capital flows in developing economies increased considerably alongside the current account excesses representing a windfall in prices of commodities, which was not easily absorbed. Consequently, emerging economies responded in these ways: First, by letting the appreciation of the actual rate of exchange finally culminating in a lessened current account excess and averting inflowing capital or two, amassing official reserves. Obviously, real rates of exchange in main developing markets increased momentously. Nonetheless, the up surging reserves were more intense. As depicted in Fig. 3 below, varying reserves and actual exchange rates in emerging economies demonstrated no association between 2000 and 2013. This renders skepticism on the proposition that states intervened mainly as a measure of avoiding losing their competitiveness. However, it replicates numerous studies, which proposes that protracted intervention usually fails to affect actual exchange charges, although it has some effect on the nominal rates of exchange. Countries are also motivated to accumulate foreign reserve stocks to avert real appreciation in the rate of exchange. If all emerging economies affirmed to let their rates of exchange to rise collectively, the loss of competitiveness would be a trivial issue. In addition, advanced states especially those, which could have benefited from the risen demand, they could possibly have allowed rates of policy interest to increase faster, therefore minimizing the inflows of capital to emerging economies. Conclusion It is evident that the accumulation of reserves renders both positive and negative influences to the emerging economies. However, the disadvantages of an over-accumulation of reserves seem to overshadow the benefits. Individually, whenever foreign exchange reserves grow so big, any additional increase would afford no extra protection. If the emerging states were to continue accumulating reserves, they would possibly have to seek greater returns, which could culminate in a diversification of reserves with a heavier stress on riskier assets comprising corporate bonds and equities, or assets denominated in currencies like the yen. Consequently, attempts at imposing fast and hard limits on reserve accumulation would prove undesirable and futile. Individual hold differing opinions on the tolerance and exposure of risks, and are ready to pay given amounts as insurance. Given the analysis above, policies should rather pay attention on the causes of excess global volatility and liquidity. It is apparent that Europe, America, and Japan (who stock the currency reserves and still responsible for most of the global trade) will continue to establish the financial setting in which developing economies run. Lest they recover their foothold, global rises in interest rates, and declines in fiscal deficits, emerging states will maintain their struggle with foreign money boons, and their pursuit for insuring against global recessions. With that, some developing countries such as Japan and China ought to adopt a more critical outlook of their foreign reserve levels and the linked expenses. Extreme accumulation of reserves is not just expensive, but it can as well culminate in overheating of credit markets and assets as well as increased inflation. A likely area for future studies, brought to light by the international financial crunch comprises coming up with better reserve adequacy approaches, which consider the likelihood of serious detrimental shocks. Reference List Aizenman, J., Jinjarak, Y. & Park, D., 2011, ‘International reserves and swap lines: Substitutes or complements?’ International Review of Economics & Finance, Vol. 20, no. 1, pp.5-18. Bracke, T and Fidora, M 2012, ‘The macro-financial factors behind the crisis: Global liquidity glut or global savings glut?’ The North American Journal of Economics and Finance, Vol. 23, no. 2, pp.185-202. Bussière, M., Cheng, G., Chinn, M.D. & Lisack, N., 2015, ‘For a few dollars more: Reserves and growth in times of crises,’ Journal of International Money and Finance, vol. 52, pp.127-145. Dadush, U and Stancil, B 2011, ‘Why are reserves so big?’ VoxEU. org, Vol. 9, pp. 270-354. Dhar, S., 2012, ‘Reserve Accumulation and Global Financial Stability: A Critical Assessment of IMF, BIS papers, Vol. 24, pp.97-113. Dominguez, K.M., Hashimoto, Y. & Ito, T., 2012, ‘International reserves and the global financial crisis,’ Journal of International Economics, vol. 88, no. 2, pp.388-406 International Monetary Fund 2015, Assessing Reserve Adequacy. Available from: . [27 July 2015]. Kim, J.I., Dabla-Norris, E. & Shirono, K., 2011, ‘Optimal precautionary reserves for low-income countries: a cost-benefit analysis,’ IMF Working Papers, pp.1-35. Morrison, W.M. & Labonte, M., 2011. China's holdings of US securities: implications for the US economy. Current Politics and Economics of Northern and Western Asia, 20(3), p.507. Pontines, V. & Rajan, R.S., 2011, ‘Foreign exchange market intervention and reserve accumulation in emerging Asia: Is there evidence of fear of appreciation?’ Economics Letters, vol. 111, no. 3, pp.252-255. Read More