Are reserve holdings in emerging Asian countries excessive? - The intertemporal balance perspective

Abstract

Under the assumption of intertemporal balance, current foreign reserve holdings should equal the present value of the sum of future current account and financial account balances. To satisfy the intertemporal balance, a testable condition indicates that the change in foreign reserves needs to follow a stationary path. We employ variant unit root tests on nine Asian emerging markets for the time period of 1989.1 to 2008.12. The univariate unit root test shows that most countries have violated the intertemporal balance due to accumulating excessive reserves, while for the time period up to 1997.6, prior to the Asian currency crises, most countries deviated from the sustainable path due to deficient reserve holdings. However, results from the panel unit root test, which particularly considers the cross country correlation, show that except for China not being on a sustainable path, the other countries do not violate the intertemporal balance. The disparate results between univariate and panel unit root tests indicate interdependence among Asian emerging markets in the era of financial globalisation and vindicate the advantages from regional financial cooperation.