How Should Emerging Economies Manage their Foreign Exchange Reserves?

Abstract

Asia has emerged as the balancing wheel of global finance. The countries of Asia now account for 70 per cent of global foreign exchange reserves, compared to only 30 per cent in 1990 and 21 per cent in the early 1970s. This paper explores theoretical interpretations for the relatively high demand for international reserves by developing countries especially in the Far East. This paper provides calculations of the minimal necessary level of international reserves based on benchmarks proposed by Wijnholds and Kapteyn, as well as a discussion of costs of reserves' holding. It therefore provides empirical proof that exchange reserve levels for many of the developing countries have far exceeded the desirable levels. Paper then discusses the steps that central banks in these developing countries can take for an effective reserve management.