Did Foreign Reserves Help Weather the Crisis?

• Author: Olivier Blanchard/Hamid Faruqee/Vladimir Klyuev
• Position: IMF Research Department

Many emerging market economies have accumulated large international reserves over the past decade (see Chart 1). For some it was a conscious attempt to insure against the impact of a crisis. For others, it was a byproduct of export-led growth strategies that included maintaining low exchange rates.

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It is hard to tell, however, whether this self-insurance was indeed successful. On the one hand, most emerging markets weathered the current crisis better than in the past. On the other hand, this could be attributed to the fact that the crisis originated in advanced economies, and to much better macroeconomic policies and frameworks in emerging economies than in the past. Indeed, as Chart 2 shows, there is no apparent relationship between the amount of reserves held before the crisis (scaled by the size of the economy) and output declines during the crisis. The same holds true when one controls for various relevant factors shaping the effects of the crisis on growth such as trade and financial openness, exposure to falling commodity prices, initial current account imbalances, or other financial vulnerabilities.

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In a similar vein, despite large differences in reserves relative to the size of the economy, various measures of market strain behaved in a similar fashion in most emerging markets. Take the case of Brazil and Mexico-the two largest Latin...