The accumulation of foreign reserves - European Central Bank

78 Pages·2006·0.8 MB·English

OCCASIONAL PAPER SERIES
NO. 43 / FEBRUARY 2006
THE ACCUMULATION OF
FOREIGN RESERVES
by an International Relations
Committee Task Force
OCCASIONAL PAPER SERIES
NO. 43 / FEBRUARY 2006
THE ACCUMULATION OF
FOREIGN RESERVES
by an International Relations
Committee Task Force *
In 2006 all ECB
publications This paper can be downloaded without charge from
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* The opinions expressed in this paper are those of the authors listed on page 6 and do not necessarily reflect those of the European
Central Bank or the national central banks that the authors are affiliated with.
© European Central Bank, 2006
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ISSN 1607-1484 (print)
ISSN 1725-6534 (online)
CONTENTS
PREFACE 6 ANNEX 3
RISKS TO AND CHALLENGES FOR THE CONDUCT
MEMBERS OF THE INTERNATIONAL RELATIONS OF MONETARY POLICY 37
COMMITTEE TASK FORCE ON ACCUMULATION 1 Background 37
OF FOREIGN RESERVES 7
2 Institutional characteristics and
monetary policy responses in
SUMMARY 8 some major reserve-accumulating
1 The puzzle of reserve accumulation economies 38
since 2002 9
2 Possible drivers of the recent ANNEX 4
reserve accumulation 13 THE FOREIGN POSITIONS OF SEVEN ASIAN
CENTRAL BANKS:
3 Domestic risks and costs of
TRENDS AND POTENTIAL RISKS 40
reserve accumulation 17
1 Background 40
4 Main trends in central bank
reserve management 19 2 Trends in the net foreign position
of seven Asian central banks 41
5 Alternative uses of accumulated
foreign assets 23 3 Potential costs of net foreign asset
holdings 42
6 Impact on yields and asset prices 24
4 Institutional arrangements related to
the management of foreign currency
reserves 44
ANNEXES
ANNEX 5
ANNEX 1
DEVELOPMENTS IN CENTRAL BANK
STYLISED FACTS OF THE ACCUMULATION OF
RESERVE MANAGEMENT AND THEIR POSSIBLE
FOREIGN EXCHANGE RESERVES 27
MARKET IMPLICATIONS 46
1 Individual countries and regions 27
1 Background 46
2 Reserves channelled into oil and
2 Main trends in reserve management
heritage funds 28
since 1999: diversification, but to
what extent? 47
ANNEX 2
MAIN DRIVERS OF RESERVE ACCUMULATION: 3 The coexistence of various foreign
A REVIEW OF THE LITERATURE 29 reserve management frameworks 51
1 Background 29 4 US and euro area fixed income
markets: can differences limit
2 Precautionary motives 30
currency diversification? 51
3 The “global savings glut” 34
5 Market implications of excessive
4 Management of exchange rates 35
foreign reserve accumulation in
5 Costs of managing exchange rates, terms of possible distortions of
and “socialisation” of exchange current bond market dynamics 55
rate risk 35
6 Unconventional monetary policies 36
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ANNEX 6
THE IMPACT OF ASIAN RESERVE ACCUMULATION
ON ASSET PRICES 55
1 Background 55
2 The role of changes in the relative
supply of Treasuries on yields: A
review of available evidence 56
3 A model to explain the impact of
Asian reserve accumulation on
ten-year Treasury yields 57
4 A model to explain the impact of
Asian reserve accumulation on
three-year Treasury yields 59
5 Impact on other asset prices 61
ANNEX 7
THE FINANCING OF THE US CURRENT
ACCOUNT DEFICIT:
A SHORT REVIEW OF THE LITERATURE AND
SOME EVIDENCE 63
1 Background 63
2 Review of the literature, and links
with current policy issues 64
3 A descriptive analysis of US
current account deficit financing 66
REFERENCES 68
LIST OF OCCASIONAL PAPERS 74
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PREFACE
PREFACE The report – on which this occasional paper is
based1 – was discussed by the IRC in June
In a number of countries, especially emerging 2005, and the authors gratefully acknowledge
market economies, the public sector has in the comments made by the Committee
recent years been accumulating sizeable cross- members on that occasion. In addition, in
border financial assets, mainly in the form of September 2005 the report was sent to the
official foreign exchange reserves. World General Council of the European Central
reserves have risen from USD 1.2 trillion in Bank (ECB) and, subsequently, to the
January 1995 to above USD 4 trillion in Economic and Financial Committee, a
September 2005, growing particularly rapidly consultative committee that contributes to the
since 2002. The impressive pace of reserve preparation of the work of the ECOFIN
growth has become an important issue on the Council.
international policy agenda and has been
considered from various perspectives,
including the financing of the growing US
current account deficits, the debate on high net
savings in the Asian economies and oil-
exporting countries, the sustainability of
reserve accumulation, and the factors behind
exceptionally low yields within and outside the
United States.
In January 2005 the International Relations
Committee (IRC), a committee established by
the European System of Central Banks (ESCB)
to deal with international monetary and
financial affairs, asked a group of ESCB
central bank experts to study the accumulation
of foreign reserves in greater detail. The
ensuing report by the IRC task force
investigated the features, drivers, risks and
costs of reserve accumulation, as well as the
other uses that certain countries have been
making of their accumulated foreign assets.
The report also reviewed the main trends in
1 Georges Pineau (ECB) chaired the IRC task force and
central bank reserve management and provided coordinated its work. Ettore Dorrucci (ECB) drafted the
paper, and the other task force members carried out the
some evidence for the impact of reserve
corresponding background studies as acknowledged in the
accumulation on yields and asset prices. footnotes to each of the seven annexes.
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MEMBERS OF THE INTERNATIONAL RELATIONS COMMITTEE TASK FORCE ON ACCUMULATION
OF FOREIGN RESERVES
European Central Bank Georges Pineau
Ettore Dorrucci
Fabio Comelli
Angelika Lagerblom
Nationale Bank van België/
Banque Nationale de Belgique Michel Soudan
Deutsche Bundesbank Gudrun Leichtlein
Banco de España Emiliano González-Mota
Banque de France Guy Levy-Rueff
Banca d’Italia Maurizio Ghirga
De Nederlandsche Bank Philipp Maier
Banco de Portugal Teresa Balcao Reis
Suomen Pankki Jouko Rautava
OTHER AUTHORS OF THIS OCCASIONAL PAPER
Deutsche Bundesbank Antje Kreye
Banco de España Lucía Cuadro Sáez
Sergio Gavilá
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SUMMARY
SUMMARY strong depreciation of their currencies, the
crisis-hit Asian economies pursued export-led
World foreign exchange reserves grew from growth supported by exchange rate regimes
USD 1.2 trillion in January 1995 to more than anchoring their currency, de jure or de facto,
USD 4.0 trillion in September 20052. Reserve to the US dollar. Third, certain features of
accumulation in this period exhibited four the domestic financial systems of EMEs,
features that seem largely unprecedented. especially in Asia, are likely to have played
Three of these features became particularly a role. Such characteristics relate mainly to:
prominent in 2002-04. First, world reserves (i) their underdeveloped local financial
grew by around 85% (or 91% if the first eight systems, entailing difficulties in properly
months of 2005 are included), at a pace three channelling domestic private savings to
times faster than in 1999-2001. Second, investment as well as inefficient and/or costly
monetary authorities in Asia, including Japan hedging markets; (ii) the resultant tendency
until March 2004, accounted for the bulk of the towards dollarisation of official and/or private
accumulation, and eight of them are currently cross-border assets on the part of certain
among the ten largest reserve holders. Third, creditor EMEs; and (iii) from a macro
fewer official creditors held an increasingly viewpoint, an excess of domestic savings over
larger share of the total accumulation. The top investment driven by either a savings glut
five reserve accumulating central banks, which (e.g. China) or an investment drought (other
accounted for almost 57% of the total reserve Asian emerging market economies). All these
accumulation on average in the period 1995- features have significant links to reserve
2001, increased their share to more than 68% of accumulation, as explained below.
the total world accumulation in 2004. The top
two, Japan and China, accounted for about half These recent drivers of reserve accumulation
of the total world accumulation in 2002-04, and seem to have one aspect in common, namely the
currently hold around 40% of the total world role played by the build-up of official foreign
stock of reserves. A fourth, equally important assets both as an outcome of and an instrument
development has come about more recently: for integration of the EMEs concerned into the
the oil-exporting countries, whose combined global financial markets. Several emerging
current account surplus is estimated to have countries, especially in Asia, have in fact
exceeded that of the Asian economies in 2005, become major players in international trade but
have emerged as a new major group of net are still underdeveloped from a financial angle.
capital exporters in the world economy. They, This asymmetry is probably one reason why
however, have accumulated assets not only in EMEs now hold around two-thirds of world
the form of “traditional” reserves, but also by reserves compared with less than 30% at the
building up foreign assets in so-called oil funds end of the Bretton Woods period in the early
– a phenomenon that is not yet fully captured by 1970s, whereas the total reserves of mature
the available statistics, including those on the economies with complete and deep financial
financing of the US external deficit. markets, excluding Japan, have remained
stable at around USD 500 billion since the early
Such an unprecedented accumulation of 1990s.
official foreign assets can be seen as the
outcome of three main drivers in addition to the As underlined in the literature, continued
more recent oil price hike. First, in the reserve accumulation may over time entail some
aftermath of the financial crises that occurred
in the 1990s and early 2000s, many emerging
2 As reported by the IMF in its latest update of the database on
market economies (EMEs) felt the need to self- Currency Composition of Official Foreign Exchange
Reserves. In the remainder of this paper, however, data are
insure against future crises. Second, at the
updated until the end of August 2005, when world reserves
beginning of their recoveries and following stood at USD 3.9 trillion.
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risks and costs, such as inflationary pressure, intervention on US Treasury yields are quite
over-investment, asset bubbles, complications different, and range from negligible to 200
in the management of monetary policy, basis points. This paper shows that purchases
potentially sizeable capital losses on monetary of US government debt securities by Asian
authorities’ balance sheets, sterilisation costs, monetary authorities might have affected the
segmentation of the public debt market and level and dynamics of their yields; in
misallocation of domestic banks’ lending. particular, there is some evidence that Japanese
purchases of US Treasuries might have had an
Two other noteworthy developments have been impact of around 65 basis points on three-year
recorded in several economies in recent years. US Treasury yields at the time of the most
First, some progress has been made towards sizeable interventions. Looking forward, the
more active management of official reserves, overall market impact of portfolio changes
resulting, for instance, in investment in a more could differ, depending on the preferences of
diversified range of instruments with longer the private sector.
maturities. Second, a substantial share of
official foreign assets has been channelled into In conclusion, a significant share of the US
vehicles with purposes other than reserve current account deficits is financed by foreign
holding. Examples include (i) the creation of official institutions pursuing objectives that
oil funds in countries such as Norway, Russia, are, to some extent, insensitive to risk-return
Venezuela, Kuwait and Oman, which aim to considerations. However, EMEs could
either stabilise their oil revenues (stabilisation progressively lessen their need for reserve
funds) or save part of them for future accumulation by developing policies such as:
generations (savings funds) or for early (i) structural and macroeconomic measures to
reimbursement of foreign debt; (ii) the foster domestic demand; (ii) financial system
establishment of “heritage funds” which have reforms both at domestic and regional levels,
more explicit return objectives in economies including bond market development; (iii) a
such as Singapore; (iii) the injection of USD 60 well-sequenced shift towards greater exchange
billion from reserve assets into three major rate flexibility, coupled with money market
state-owned commercial banks in China in reforms and, possibly, financial account
order to increase their capital base for their liberalisation; (iv) regional economic
partial privatisation; and (iv) the allocation of surveillance and monetary cooperation which,
USD 15 billion to banks in the Taiwan Province ceteris paribus, would reduce the need for
of China (hereinafter called Taiwan) for use in unilateral reserve accumulation.
major domestic investment projects. The
effects of these innovative ways of using 1 THE PUZZLE OF RESERVE ACCUMULATION
official foreign assets are still to be fully SINCE 2002
understood, in particular with regard to the link
between exchange rate and fiscal policy (e.g. in The accumulation of world foreign exchange
Russia), between the macroeconomic and the reserves (hereinafter called reserves)3 has
micro-prudential dimension of economic exhibited largely unprecedented features since
policy (e.g. in China), and between the 2002 with respect to: (i) the size and pace of the
management of very liquid, low-risk assets at accumulation, (ii) the degree of concentration
central bank level and the management of of ownership, and (iii) the geographical
longer-term, more return-oriented portfolios distribution.
by other financial entities (e.g. in Singapore).
3 For further evidence, see Annex 1. In this paper the
Regarding the impact of reserve accumulation expression “reserves” always refers to foreign exchange
reserves – i.e. reserves net of gold, special drawing rights
on yields, in the existing literature the
(SDR) and reserve positions at the IMF – unless otherwise
estimates of the effect of foreign exchange specified.
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1 THE PUZZLE
OF RESERVE
Table 1 Year-on-year changes in foreign exchange reserves and their contribution to global
reserve growth ACCUMULATION
SINCE 2002
(January 1995–August 2005)
2002–2005 1999–2001 1997–1998 1995–1996
USD Contribution USD Contribution USD Contribution USD Contribution
bn to world bn to world bn to world bn to world
growth (%) growth (%) growth (%) growth (%)
China 536 29.0 67 14.7 36 47.8 50 14.4
Japan 443 24.0 177 39.0 -4 -5.2 91 26.1
Taiwan 130 7.1 30 6.7 2 2.6 -5 -1.5
Russia 114 6.1 26 5.6 -2 -2.8 9 2.6
Korea 102 5.5 49 10.8 21 27.7 8 2.2
India 92 5.0 18 3.9 7 9.4 0 0.0
Malaysia 49 2.7 3 0.7 -1 -1.8 2 0.4
Singapore 41 2.2 1 0.3 -3 -3.4 18 5.2
Algeria 33 1.8 12 2.5 2 2.6 2 0.5
Brazil 19 1.0 2 0.3 -14 -19.0 22 6.2
World 1,849 100 455 100 76 100 349 100
Sources: IMF and ECB Staff calculations.
First, while world reserves more than tripled in however, world reserves have risen by 91%
the past ten years, they have almost doubled in (i.e. almost USD 2 trillion), which seems
the last four years alone, with the rate of largely unprecedented. In terms of both reserve
accumulation increasing dramatically since holdings and contribution to world reserve
2002. World reserves have in fact grown from growth, the top three accumulators have been
USD 1.2 trillion in January 1995 to more than China, Japan and Taiwan. In the case of a few
USD 4.0 trillion in September 2005 (according countries such as Turkey and, since 2003,
to the latest data for 2005 made available by Argentina and Brazil, such moves can still be
the IMF)4, but the pace varied significantly interpreted as reserve replenishment, but in
throughout the period. Between 1995 and 2001, most other cases the rate of accumulation
the financial crises affecting a number of EMEs appears particularly high not only in
in a context of increasingly liberalised capital comparison with the previous seven years, but
flows, and the ensuing need to use reserves and also by historical standards.
then replenish them as self-insurance against
future crises, were important factors. However, Looking back, while world foreign exchange
in 1997-98, in particular, global reserves reserves doubled from USD 16 billion to USD
increased by just USD 76 billion, with crisis- 33 billion in the decade from 1959 to 1969, they
hit countries considerably reducing their then tripled in just three years, between 1970
foreign assets (see Table 1). Conversely, world and 1972, reflecting large interventions at a
reserves grew significantly – by around 30% – time when the Bretton Woods system was
in 1995-96 and 1999-2001. In 1995-96 this unravelling. Since the early 1970s, i.e. the end
growth was mainly driven by the interventions of Bretton Woods period, reserve assets have
of China and Japan, which accounted for 14%
and 26% of world reserve growth respectively. 4 See the IMF Currency Composition of Official Foreign
In 1999-2001, the desire for self-insurance Exchange Reserves (COFER) database. In the remainder of
this paper, data are updated until the end of August 2005,
gained momentum among reserve when world reserves stood at USD 3.9 trillion.
accumulators; in particular, the reserves lost in 5 ASEAN stands for Association of East Asian Nations, the
members of which are Brunei Darussalam, Cambodia, Laos,
1997-98 were replenished by the ASEAN-5
Myanmar, Vietnam and the so-called ASEAN-5 countries:
economies5 and Russia. Since January 2002, Indonesia, Malaysia, Philippines, Singapore and Thailand.
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