Reserves Prove Their Usefulness as Global Economic Crisis Bites

• Author: Peter Kunzel/Yinqiu Lu/Christian Mulder/Jukka Pihlman
• Position: IMF Monetary and Capital Markets Department

After years of large-scale global accumulation of foreign exchange reserves, and even talk of excessive reserves, official reserves are now being drawn upon in many countries and are proving their usefulness.

The global financial crisis has put back in the spotlight the issue of countries maintaining enough foreign exchange reserves .

The IMF convened its second annual Roundtable of Sovereign Asset and Reserve Managers in Washington, D.C., in February, 2009. The event-designed to enable the exchange of ideas and experiences in sovereign asset and reserve management-was attended by delegates from central banks, ministries of finance and sovereign asset managers from 32 countries, representatives from select international institutions, and private sector representatives.

The theme of the roundtable was policy and operational issues confronting reserves and sovereign assets managers in the current financial crisis, and heightened market volatility.

Reserve adequacy revisited

Previous international financial crises have shown that holding and managing sufficient reserves of foreign currency, and disclosing adequate information on them to markets, helps a country prevent and weather external crises.

Core indicators of reserve adequacy, notably the ratio of reserves to short term external debt, have thus far been useful, but a key question is how buffers based on this criterion will hold up in a prolonged crisis, and with increased exposures to intrabank debt and portfolio flows.

The core indicator of reserve adequacy emerged after all from, and was tested in, crises when problems originated in emerging market countries and spread through contagion. The current problems are, however, closely related to the suppliers of capital-advanced-country banks in particular.

Bilateral swap lines, such as those arranged recently between some emerging market economies and the U.S. Federal Reserve, were well received. The lines were seen as both providing the option of gaining quick access to additional liquidity and mitigating the likelihood of a crisis due to the positive reputational effect even when countries did not draw on them.

Similarly, countries saw a need for additional fast-disbursing liquidity facilities of the IMF to augment resources available to countries to get through a prolonged crisis and expand the set of countries that can...