IMF Unveils New Way of Assessing Country Reserves

IMF develops first comprehensive framework for assessing reserve adequacy

Aim is to help strike balance between benefits, costs of holding reserves

Prudent level depends on country’s economic, financial structure

Reserves—the assets denominated in foreign currency, plus gold, held by a central bank—occupy an important place in the policy toolkit of most economies. Together with sound policies, they can help reduce the likelihood of balance of payment crises and preserve economic and financial stability. In addition to these important benefits, reserves also have costs.

Although the global financial crisis highlighted the importance of adequate reserves, there is little consensus on how to determine the desired level of reserve holdings for a given country. A new IMF report aims to fill this gap by outlining a framework for discussing reserve adequacy issues in the context of the IMF’s regular “health checks” of its members’ economies, also known as Article IV consultations.

“The framework provides some tools for quantifying the risks facing a country,” said Nathan Porter of the IMF’s Strategy, Policy, and Review Department, one of the report’s authors. “Based on the risks a country needs to cover, the framework helps country authorities decide how much reserves might be needed.”

Role of reserves

Countries hold reserves for a variety of reasons: to build confidence in the national currency, counter disorderly market conditions, support the conduct of monetary policy, build assets for intergenerational purposes, or influence the exchange rate, the report notes.

Countries may want reserves on hand for precautionary purposes—that is, to provide space to country authorities to respond to potential shocks, prevent chaotic market conditions, and avert economic dislocation. They may also hold them for nonprecautionary purposes—for example, an oil-exporting country may set aside as reserves a portion of its revenue to preserve wealth for future generations.

Assessing the appropriate level of reserves to hold is challenging—not just because of the multiple roles played by reserves, but also because of the complexity of quantifying external risks across countries, the IMF report notes.

Greater country specificity

Because the role played by reserves—and hence a country’s reserve needs—differs depending on the type and structure of the economy, different tools are needed to assess reserves in different types of economies. The new framework...