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International Reserves and Pooling
Hernán Lacunza
Central Bank of Argentina
Plan
• Reserves accumulation: theoretical and empirical models
• Optimal reserves level: adequacy indicators and econometric analysis
• Argentina: accumulation and sterilization
• Pooling reserves: Asia vs. Latin America experiences
2
International Reserves of Central Banks
International Reserves (world total), 1948-2004
3,500,000
3,000,000
2,500,000
Million of U$S
4,000,000
12.7%
2,000,000
5.0%
1,500,000
1,000,000
1.75%
500,000
19
48
19
50
19
52
19
54
19
56
19
58
19
60
19
62
19
64
19
66
19
68
19
70
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
0
Constant Dollars
Current Dollars
3
Reserves accumulation: a widespread
phenomena
0.85
0.80
0.75
0.65
0.60
0.55
0.50
0.45
0.40
Share of Countries with positive reserve accumulation
20
04
20
02
20
00
19
98
19
96
19
94
19
92
19
90
19
88
19
86
19
84
19
82
19
80
19
78
19
76
0.35
19
74
Share
0.70
Mean for Period
Annual Growth Rates Volatility
Period
Constant Dollars
1948 - 1970
1973 - 1998
1998 - 2005
2.54
1.82
0.48
4
Reserves accumulation : country groups
International Reserves (world total), constant dollars, 1973-2004
1,400,000
1,000,000
800,000
600,000
400,000
200,000
0
19
73
19
75
19
77
19
79
19
81
19
83
19
85
19
87
19
89
19
91
19
93
19
95
19
97
19
99
20
01
20
03
Millions of constant dollars
1,200,000
Developed
Emerging
Others
5
Global Dynamics : Stylized Facts
Global Monetary
Standard
Dollar
Global Exchange
Rate System
Trade Openness
Fixed
Flexible
Moderate
Low
High
Financial
Openness
Very Low
Moderate
High
Reserve
Accumulation
Slow
Moderate
Very Fast
1945
1960
1975
1990
2005
6
Demand for Reserves Theory
- Traditional Approach
Level of trade (+)
Volatility of trade (+)
Opportunity Cost (-)
Marginal Propensity to Import (-)
- Modern Approach
Insurance against sudden stops
Financial crises prevention
Reduction of Sovereign Risk
- Competitiveness/Real Exchange Rate
7
Traditional Approach: Some Models (1)
a) Heller (1966)
b) Hamada and Ueda (1977)


 log( rm) 
*
RH  
 1
1
 log


2 
R
C) Frenkel and Jovanovic (1981)
1
*
RFJ
 C 3 2 r
where
C
1
4
*
HU

1 
 1 

1  2
2
 rm  
d) Kelly (1970)
RK* 
R0
m0
4
 c  e
e
1
2
 c
1
2
 b
m2r 2 a
e) Clark (1970)
RC*
Y *
0
RC*
0
r
RC*
0
m
RC*
0
 5
8
Modern approach (2):
Self-insurance against Sudden Stops
Experiences
Argentina-94
Argentina-99
Argentina-01
Chile-98
Colombia-98
Czech Republic-97
Ecuador-99
Germany-93
Indonesia-97
Japan-97
Korea-97
Mexico-94
Peru-97
Philippines-97
Portugal-92
Spain-92
Sweden-92
Thailand-96
Turkey-94
Turkey-98
Turkey-01
% change of reserves
-40.95
-14.17
-48.61
-22.30
-18.29
-33.44
-72.90
-43.03
-24.48
-10.68
-41.14
-85.16
-6.58
-31.54
-40.63
-44.12
-35.52
-37.22
-53.06
-10.94
-34.89
Source: Calvo, Izquierdo and Mejía (2004)
• Aizenman and Marion (2004):
Reserves are precautionary saving
when countries are restricted to
international liquidity.
• Aizenman and Lee (2005): Banks
intermediate between external funds
and long term domestic investment
projects. Investment are decided
before a sudden stop occurs.
Because there is not a credible
international lender of last resort,
build-up reserves is a self-insurance
policy which avoid the cost of a
premature liquidation of assets.
9
Modern approach (3):
Reserves and Financial Crisis
• Distayat (2001): Risk
adverse countries pay
a higher opportunity
cost for reserve to
reduce crisis
probability.
STOCK MARKETS AND INTERNATIONAL RESERVES
50%
COL
(% stock market FALL in USD
during May/June turmoil)
TUR
40%
BRA
HUN
30%
POL
MEX
SAF
IND
• Li and Rajan model
(2005): Reserves could
compensate for a weak
fundamentals.
CHR
MOR
INDS
ARG
20%
RUS
PHI
CHN
EGY
PER
CHI
KOR
THA
10%
MAL
VEN
0%
0%
10%
20%
30%
40%
(International reserves as % of GDP in 2005)
Source: Morgan Stanley and IMF.
50%
• Feldstein (1999):
Reserves make an
attack on the currency
60%
less likely or improves
the ability to act a more
10
orderly adjustment.
Modern approach (4): Reserves and Country Risk
0.35
Morocco
Reserves/GDP
0.30
Bulgaria
0.25
Egypt
Ukraine
Russia
0.20
Venezuela
Peru
0.15
Philippines
Argentina
Turkey
Poland
Colombia
0.10
Mexico
South
Af rica
0.05
Panama
Brazil
Ecuador
0.00
0
100
200
300
400
500
600
700
800
EMBI+
• Ben-Bassat and Gottlieb (1992): positive relationship between cost of default and demand
of reserves. Countries which had experienced defaults should demand more reserves.
• Soto et al. (2004): Higher reserve levels imply higher ratings and lower risk.
11
• Turner and Moreno (2004): “Battle for reserves”, a country is more credible than a similar
one when have higher reserves.
Competitiveness and Exchange Rate Regime
Systematic accumulators
Exchange rate regime
Frequency
Percentage
Fixed rate
78
26%
Intermediate regime
20
7%
Managed floating
108
35%
Independent floating
99
32%
Total
305
100%
Monetary regime
Frequency
Percentage
Full-fledged inflation targeting
16
7.1%
Implicit price stability anchor
18
8%
Monetary anchor
4
1.8%
Inflation targeting lite
77
34.4%
Weak anchor
26
11.6%
Exchange rate peg
77
34.4%
Monetary nonautonomy
21
9.4%
Total
224
100%
12
Reserves and Exchange Rate Regime
Systematic accumulators
Exchange rate regime at t + 1
Fixed
Intermediate
exchange rate
regimes
Exchange rate regime at t
Fixed
exchange rate
Intermediate
regimes
Managed
floating
Independent
floating
Managed
floating
Independent
floating
Total
52
0
3
0
55
94.5%
0.0%
5.5%
0.0%
100%
2
10
1
0
13
15.4%
76.9%
7.7%
0.0%
100%
4
5
72
3
84
4.8%
6%
85.7%
3.5%
100%
2
0
8
72
82
2.4%
0.0%
9.8%
87.8%
100%
60
15
84
75
234
25.6%
6.4%
35.9%
32.1%
Total
100% 13
Systematic Accumulation and Sterilization
Change in Monetary Base
50%
R2
40%
30%
China 1997
Algeria 2004
China 2004
20%
Ukraine 2005
10%
Singapore 1995
Malaysia 1993
0%
0%
China 1995
10%
20%
30%
40%
Change in International Reserves
50%
14
Optimal Reserves Level: Adequacy Indicators
• De Beaufort Wijnholds et al. (2001)
a) Commercial Criterion
1
R adequate 
M
3
b) Financial Criteria
R2adequate  DECP
R3adequate  0.125 * M 2 * RP
c) Commercial and Financial Criterion
4
adequate
R
 DECP  0. 125 * M 2 * RP 
M
3
15
Observed Level of Reserves ( logarithmic scale)
Adequacy Indicators (2004):
Financial and Commercial Criterion
13.80
China
13.30
12.80
More than Adequate
Korea
12.30
India
11.80
Russia
11.30
M alaysia
10.80
Thailand
M exico
10.30
Venezuela
Brazil
Less than Adequate
Indonesia
9.80
Argentina
Chile
9.30
8.80
8.80
9.80
South Africa
10.80
11.80
12.80
13.80
Adequate Level of reserves (logaritmic scale)
Selected LATAM contries
Other Emerging countries
16
International Reserves (Billion of U$S)
Reserves and Short-Run External Debt (2005)
70
M exico
B razil
60
50
Turkey
Thailand
40
P o land
30
A rgentina
Venezuela
20
So uth
A frica
M o ro cco
Chile
P hilippines
10
Ecuado r
0
0
5
10
15
20
25
30
35
40
45
50
Short-Run External Debt (Billion of U$S)
17
Optimal Reserve Level: Econometric Analysis
Dependent Variable: Log. Reserves to GDP
Standard
Explanatory variables
Coefficient
error
Inertia (Reserves- GDP in t-1)
0.8529464 ***
0.0256205
GDP PPP per inhabitant
0.0016251 *
0.0009036
GDP PPP per inhabitant ^ 2
-5.98e-06 **
2.76e-06
Imports / GDP
0.0829643 *
0.0491948
Capital inflows / GDP
.0428755 *
.0219807
Volati lity of Exports
- 0.0226167
0.018692
Volatility of Capital Inflows
- 0.0123594
0.0227256
Opportunity cost
- 0.0422273
0.0641736
Regional imitation
0.0041718 ***
0.0008114
Pure float
0.0001283
0.0299053
Managed float
0. 0243429
0.0312476
Crawling Peg
- 0.0054370
0.0281226
Indeterminate exchange rate regime
0.0750048
0.1309026
Shift Dummy Variable1990
0.0711959 **
0.0285057
- 0.0142478
0.0275846
Shift Dummy Variable1998
Constant
- 0.4902925 ***
0.1621275
Number of countries
Number of observations
P value
0.000
0.074
0.032
0.094
0.053
0.228
0.587
0.512
0.000
0.997
0.437
0.847
0.568
0.014
0.606
0.003
139
2638
18
Reserves Hoarding as Prudent Monetary Policy
International Reserves of Argentina
28.0 billion
26.3 billion
30.00
Billion of US$
25.00
20.00
15.00
10.00
5.00
9.4 billion
0
19
Source of Reserve Accumulation in Argentina
12,000
20,000
15,000
8,000
10,000
4,000
0
-5,000
-4,000
-10,000
-8,000
-15,000
-12,000
-20,000
Annual Change of Reserves
Current Account (right hand axis)
Capital Account (right hand axis)
20
Million of U$S
0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Million of U$S
5,000
Prudent Monetary Policy:
deep sterilization of reserves purchases
Sterilization of USD purchases
(quarterly moving averages, 2005-2006)
$ million
200
250%
150
2005 average:
100
150%
78%
50
50%
0
-50%
-50
2006 average:
-100
70%
-150%
-150
-250%
Base money expansion due to USD purchases
-200
Base money absorption through repos+CB Bills & Notes+Redisc.+Cash requirem.+Pub. sector oper.
Source: BCRA.
6
6
20
0
3-
8-
20
0
7-
20
0
6
-350%
3-
6
6-
20
0
3-
6
5-
20
0
3-
6
43-
6
20
0
3-
20
0
3-
6
3-
2-
20
0
1-
3-
-2
00
5
12
-2
00
5
11
3-
3-
5
-2
00
5
20
0
10
3-
5
93-
5
20
0
8-
20
0
3-
5
7-
20
0
3-
5
6-
20
0
3-
53-
5
20
0
4-
3-
5
20
0
3-
3-
5
20
0
3-
2-
20
0
13-
5
Sterilization as % of Base money expansion due to USD purchases (right hand axis)
-250
21
Argentina: Scaled Reserves
0.08
0.60
0.06
0.40
0.04
0.20
0.02
0.00
0.00
20
05
0.80
19
99
20
01
20
03
0.10
19
93
19
95
19
97
1.00
19
87
19
89
19
91
0.12
19
81
19
83
19
85
1.20
19
75
19
77
19
79
0.14
19
73
1.40
22
Reserves/Import
Reserves/M2
Reserves/GDP (right hand axis)
Argentina: Reserves and External Debt
External Debt / Reserves
2004
2005
2006
10,69
4,03
3,94
Brazil
4,18
3,23
3,06
Chile
2,74
2,58
2,57
Mexico
2,50
2,14
1,89
Korea
0,85
0,76
0,71
China
0,38
0,30
0,25
Thailand
1,05
0,92
0,85
Argentina
23
Results: less vulnerability to foreign shocks
EMBI+ Argentina/EMBI+ Emerging Markets
Argentinian Risk vs Emerging Markets Risk
2,30
2,20
2,10
2,00
1,90
1,80
1,70
1,60
1,50
24
Risks and Hedge
Type of shock
Hedge
Global (non diversifiable)
Reserve Accumulation
Regional (partially diversifiable)
Multilateral Institutions
Idiosyncratic (diversifiable)
Regional Reserve
Founds (pooling)
25
Reserve Pooling
Advantages
Direct
• Reducing reserve costs
• Avoiding CB lender of last resort
limitations
• Enhance macro and financial
stability
Indirect
• Contributing to regional capital
market development
• De-dollarization (systemic currency
missmatch)
• Reducing external funding costs
Weaknesses
• Symmetric shocks hitting
region countries (Mundell’s
OCA)
• Moral hazard due to
asymmetric (endogenous vs.
exogenous problems) or
incomplete (liquidity vs.
solvency) information
• Difficulties in monitoring,
“conditionalities” and
enforcement
• Political Economy: loan =
lender
26
Regional Pools: Asian Experience (ASEAN + 3*)
2000: Agreement to inject liquidity in economies with Balance of
Payment problems (as in 97-98 crisis)
Long Run Lending
2003: Asian
Bond Fund
06/2003:ABF1
(U$S)
Promoting domestic
currency bond markets
06/2005:ABF2
(local currency)
U$S 2 billon
* Honk Kong, Indonesia, Malaysia, Philippines, Singapore,
Thailand, China, Australia, Japan, New Zeland
27
ABF2 - Components
28
ABF2 – Market Shares
29
Regional Pools: Latin America*
1976: Andean Reserve
Fund
1991: Latin American
Reserve Fund (FLAR)
Objective: helping member countries during episodes of balance of
payment difficulties via direct lending or offering collateral to potential
lenders
Aims: balance of payments, debt restructuring, liquidity and
contingencies
Assembly: Ministers of Finance
Board of Directors: Central Bank Governors and Executive President
Capital: U$S 2.100 million
Risk Rating: Aa2 Moody’s (stable), A+ S&P
* Bolivia, Colombia, Chile, Ecuador, Peru, Venezuela
30
Concluding Remarks
Why do so many countries follow an aggressive strategy of
reserve accumulation?
 Asymmetric financial and trade integration: high volatility
for emerging countries
 Global imbalances: non negligible probability of sudden
changes in the international economy
The lack of a reliable global financial architecture with a
lender of last resort (after financial crisis of the 90´s)
 Competitive imitation among emerging countries,
specially during intermediate development stages (U
shape relationship)
 Because of the financial markets imperfections, liquidity is
a reasonable way of self-insurance
31
Concluding Remarks and Policy Lessons (2)
 Although self-insurance could be considered a second best
solution, reserves pools are not yet developed in the region.
Problems of political economy
Multilateral institutions seem unable to manage a pool.
 Although there are not optimal level indicators, some “proxies”
and econometric models show that there is still room for the
continuity of this policy (checking the monetary effects)
32