Currency Composition Research Articles

Foreign Currency Lending and Banking System Stability - New Evidence from Turkey

Regulators in developing countries have started to strict banks' foreign currency (FC) lending. Following others, in June 2009, in what is considered surprise the Turkish Government removed a provision from its existing laws that had allowed Turkish residents to borrow in foreign currency from banks operating in Turkey. The development ended a long era of foreign currency lending for consumer loans. This paper studies the determinants and consequences of foreign currency lending for banks in Turkey in the run-up to this significant policy change. By using detailed balance sheet data on the Turkish lira and foreign currency composition of bank assets and liabilities between 2002 and mid-2009 when the policy change was initiated, we evaluate the drivers of FC lending by banks in Turkey along with consequences for the banking system in particular and for the economy in general. We highlight possible risks to the Turkish banking system as a result of the system's heavy exposure to exchange rate and default risks. In doing so, we show that the policy change was not necessarily a surprise but a cautionary step in the right direction to help keep Turkish banking system stable.

A Revise about Dynamic Adjustment of Reserve Currency Composition

This manuscript is a revision about the model in the article “Adjusting the Currency Composition of China’s Foreign Exchange Reserve”. We extend our previous work into discrete time domain and correct some improprieties.

Credit Risk Spreads in Local and Foreign Currencies

Governments, corporations, and even small firms raise and denominate capital in different currencies. We examine the micro‐level factors that should be considered by a borrower when structuring debt denominated in various currencies. This paper will show how the currency composition of debt affects the cost of debt through the interaction with the risk of company's assets. We look at the currency mismatch in the firm and analyze its credit spread within a Merton's type model with bankruptcy. We show that foreign currency borrowing is cheaper when the exchange rate is positively correlated with the return on the company's assets. The determining factor is not just whether a given company is an exporter or importer, but rather the statistical correlation between the rate of return on the firm's assets and changes in the exchange rate.

Foreign Reserves’ Strategic Asset Allocation

Despite foreign reserves’ strategic asset allocation relies mainly on Modern Portfolio Theory (MPT), the unique characteristics of central banks obliges them to articulate and reconcile typical optimization procedures with reserves’ management objectives such as providing confidence regarding the ability to meet the country’s external commitments. Moreover, further involvedness come from broad economic factors as diverse as the openness of capital and current accounts, external debt’s maturity and currency composition, and exchange rate regime.Therefore, in order to alleviate the divergence from theory and practice regarding foreign reserves’ strategic asset allocation, this paper describes the methodologies and procedures developed and employed by the Foreign Reserves Department of Banco de la Republica. The mainstay of the paper is a long‐term‐dependence‐adjusted and non‐loss‐constrained version of the Black‐Litterman model for obtaining the efficient frontier from a set of investments complying with safety, liquidity and return criteria, where the choice of the portfolio which maximizes utility makes use of an estimation of the Board of Directors’ risk aversion.Results exhibit the effects of the unique nature of foreign reserves management for emerging markets. Typical features of foreign reserves management by central banks, such as non‐loss restrictions due to capital preservation objectives, result in increased complexity in the optimization process and in asset allocations significantly distant from standard MPT’s optimality.

Currency composition of international bonds: The EMU effect

We analyze the impact that the launch of the EMU had on the currency denomination of private international bond issues in 1990–2006 using micro-level data. Our stylized model predicts that the introduction of the euro would lead to an increase in the share of euro-denominated debt and a decline in the share of dollar-denominated debt issued by firms located in countries outside both the United States and the euro area. Moreover, our model predicts that the euro effect would be particularly pronounced for nonfinancial firms. Our empirical results are consistent with these predictions. In addition, we find that among nonfinancial firms, the impact on new issuers is larger than on seasoned issuers. Extending the model to allow for differences in issuance volumes across future monetary union countries prior to integration, we also predict larger increases in euro-denominated issuance among firms from smaller monetary union countries. We confirm this prediction for international bond issues by euro-area firms.

How Do Exchange Rate Regimes Affect Firms' Incentives to Hedge Currency Risk? Micro Evidence for Latin America

Using a unique dataset with information on the currency composition of firms' assets and liabilities in six Latin-American countries, I investigate how the choice of exchange rate regime affects firms' foreign currency borrowing decisions and the associated currency mismatches in their balance sheets. I find that after countries switch from pegged to floating exchange rate regimes, firms reduce their levels of foreign currency exposures, in two ways. First, they reduce the share of debt contracted in foreign currency. Second, firms match more systematically their foreign currency liabilities with assets denominated in foreign currency and export revenues--effectively reducing their vulnerability to exchange rate shocks. More broadly, the study provides novel evidence on the impact of exchange rate regimes on the level of un-hedged foreign currency debt in the corporate sector and thus on aggregate financial stability.

Criteria for Broadening the SDR Currency Basket

The paper explores the pros and cons of maintaining the current “freely usable currency” criterion, and clarifies indicators for assessing it. The freely usable concept and its two key elements—currencies should be "widely used" and "widely traded"—are set out in the Articles and serve important operational purposes. A formal requirement for a currency to be freely usable was adopted for SDR valuation only in 2000, although considerations relating to this concept had been taken into account earlier. Indicators for assessing freely usable currencies were first discussed in 1977, and are updated to reflect subsequent developments in financial markets and data availability. The paper suggests as indicators for "wide use" the currency composition of foreign exchange reserves, international debt securities, and international bank liabilities; and for "wide trading" it proposes foreign exchange spot market turnover.

RENMINBISING CHINA'S FOREIGN ASSETS

AbstractSince the 2008 global financial crisis, China has rolled out a number of initiatives to actively promote the international role of the renminbi and to denominate more of its international claims away from the US dollar and into the renminbi. The present paper discusses the factors shaping the prospects of internationalising the renminbi from the perspective of the currency composition of China's international assets and liabilities. These factors include, among others, underlying valuation and management of the renminbi.

Corporate sector liability dollarization and exchange rate balance sheet effect in Turkey

In this study, we investigate the causes and balance sheet effect consequences of Liability Dollarization (LD) of nonfinancial sectors in Turkey. The dynamic panel data Generalized Method of Moments (GMM) results suggest that both sector specific and macroeconomic variables are significant in explaining the corporate sector LD. Industries appear to partially match the currency composition of their debt with their income streams. Devaluations are found to be contractionary, in terms of investments and profits, for sectors with higher LD. Macroeconomic instability affects the performance of the industries negatively. Our results also stress the importance of strong macroeconomic policy stance for an endogenous dedollarization process.

Shifts in Portfolio Preferences of International Investors: An Application to Sovereign Wealth Funds

Reversals in capital inflows can have severe economic consequences. This paper develops a dynamic general equilibrium model to analyse the effect on interest rates, asset prices, investment, consumption, output, the exchange rate and the current account of a shift in portfolio preferences of foreign investors. The model has two countries and two asset classes (equities and bonds). It is characterised by imperfect substitutability between assets and allows for endogenous adjustment in interest rates and asset prices. Therefore, it accounts for capital gains arising from equity price movements, in addition to valuation effects caused by changes in the exchange rate. To illustrate the mechanics of the model, we calibrate it to analyse the consequences of an increase in the importance of sovereign wealth funds (SWFs). Specifically, we ask what would happen if ‘excess’ reserves held by emerging markets were transferred from central banks to SWFs. We look separately at two diversification paths: one in which SWFs keep the same allocation across bonds and equities as central banks, but move away from dollar assets (path 1); and another in which they choose the same currency composition as central banks, but shift from US bonds to US equities (path 2). In path 1, the dollar depreciates and US net debt falls on impact and increases in the long run. In path 2, the dollar depreciates and US net debt increases in the long run. In both cases, there is a reduction in the ‘exorbitant privilege’, ie, the excess return the United States receives on its assets over what it pays on its liabilities. The model is applicable to other episodes in which foreign investors change the composition of their portfolios.

Shifts in Portfolio Preferences of International Investors: An Application to Sovereign Wealth Funds

Reversals in capital inflows can have severe economic consequences. This paper develops a dynamic general equilibrium model to analyse the effect on interest rates, asset prices, investment, consumption, output, the exchange rate and the current account of a shift in portfolio preferences of foreign investors. The model has two countries and two asset classes (equities and bonds). It is characterised by imperfect substitutability between assets and allows for endogenous adjustment in interest rates and asset prices. Therefore, it accounts for capital gains arising from equity price movements, in addition to valuation effects caused by changes in the exchange rate. To illustrate the mechanics of the model, we calibrate it to analyse the consequences of an increase in the importance of sovereign wealth funds (SWFs). Specifically, we ask what would happen if ‘excess’ reserves held by emerging markets were transferred from central banks to SWFs. We look separately at two diversification paths: one in which SWFs keep the same allocation across bonds and equities as central banks, but move away from dollar assets (path 1); and another in which they choose the same currency composition as central banks, but shift from US bonds to US equities (path 2). In path 1, the dollar depreciates and US net debt falls on impact and increases in the long run. In path 2, the dollar depreciates and US net debt increases in the long run. In both cases, there is a reduction in the ‘exorbitant privilege’, ie, the excess return the United States receives on its assets over what it pays on its liabilities. The model is applicable to other episodes in which foreign investors change the composition of their portfolios.

Особенности управления резервными активами в странах Азии

The article focuses on reasons and consequences of rapid growth of reserve assets in Asian countries over the last decade. The main trends related to changes of structure, currency composition and management of reserve assets in the region are considered by the example of China, Japan, Korea, Singapore and India. Special emphasis is placed on the problem of excess reserves and their diversification during the global financial crisis.

DOLLAR AND ITS ALTERNATIVES AS A RESERVE CURRENCY

This paper provides an evaluation on the global reserve currency status of U.S. dollar and the debates on reserve currencies. This evaluation involves the examination of some quantitative data concerning the economic facts of the leading countries, the currency composition of foreign exchange holdings in the world and the official reserve assets of the major reserve-accumulating countries. Furthermore it calls attention to the criticisms towards the viability of the dollar as a global reserve currency and analyzes the suggestions and ideas proposed by countries and county groups.

Towards an Expanded Role for Asian Currencies: Issues and Prospects

Notwithstanding incumbency advantages and network effects enjoyed by the United States (US) dollar, considerations about the stability of its value have led Asian countries to fear they are holding their foreign exchange reserves in a depreciating currency. At the same time, it pays for the regional countries to adjust their reserve currency composition to match the point of reference of their exchange rate policy. This paper examines empirically which regional currency or currencies seem to matter for exchange rate determination in Asia beyond the very short term. To this end, we employ country-specific Vector Autoregressive (VAR) models to compare the relative impact which fluctuations in the Asian Currency Unit (ACU), yuan and yen separately have on movements of Asian currencies. Contrary to recent evidence based on daily data, we found monthly exchange rates variations in the region are more heavily influenced by the cumulative effect of key Asian currencies than by the yuan or the yen individually within the sample period we used. To the extent that exchange rates in the region shift over time from benchmarking the US dollar towards a broad range of Asian currencies, Asian central banks will find it more attractive to cross-hold Asian bonds. This calls for the development of deep private markets in such assets, as well as institutional prerequisites for internationalizing key regional currencies.

India's International Reserves: How Large and How Diversified?

Asymmetric foreign exchange intervention by the Reserve Bank of India (RBI) has resulted in a sustained accretion of India’s foreign exchange reserves. The reserve buildup in India has certainly been impressive, rising from around US$5-6 million in 1991, to nearly US$300 billion in mid 2008. In addition to addressing the issues of reserve adequacy, this paper examines the forms the reserves have taken (asset and currency composition), and the extent to which India’s reserve holdings are diversified. The issue of reserve adequacy was made apparent during the 1990s and early 2000 when rapid reserve depletion became a defining and determining feature of the series of currency crises that hit emerging economies. In order to assess the adequacy of India’s stock of international reserves, the paper considers a few standard measures used in literature and finds that India’s reserve stock is more than adequate, placing them in a much better position than many other emerging economies. The paper goes on to examine the asset and currency composition of such reserves. More than 50 percent of India’s reserve holdings have been in the form of foreign currencies and deposits as cash, followed by investments in foreign securities and gold deposits, in that order, reflecting a high degree of risk aversion by the RBI in the management of the reserves. While data on asset composition are available, the currency composition of reserves is a well-guarded secret. Hence the paper undertakes some simulation exercises to arrive at some reasonable guesstimates of such a composition. The paper also makes use of the Treasury International Capital Reporting System (TIC) data to track India’s investments in the U.S. securities, thereby assessing the weight of U.S. dollar assets in India’s reserve holdings.

International Reserves Management and Currency Allocation: A New Optimisation Framework Based on a Measure of Relative Numeraire Risk (RNR)

This paper addresses the challenges involved in optimising the currency allocation of international reserves portfolios based on ex ante risk-return statistics measured in one numeraire (e.g. chosen to reflect the economy’s import currency composition), while reserves size continues to be scrutinised ex post in another numeraire (i.e. USD). This paper proposes the Relative Numeraire Risk (RNR) measure to capture quantitatively (basis points) how Pareto-suboptimal efficient frontier in one optimisation numeraire will appear in different report numeraire(s) and outlines the RNR reserves management framework. Experiments entailed 6 numeraire choices on weekly (2000 to H1-2009) FX/government bond data in 4 reserves currencies.

Does Procyclical Fiscal Policy Reinforce Incentives to Dollarize Sovereign Debt?

This paper explores the link between the cyclical patterns of macroeconomic and policy variables and the currency composition of domestic sovereign debt in emerging market countries. The empirical analysis is anchored in an equilibrium model, in which the dollarization of sovereign debt arises as a result of the optimal portfolio choices by risk-averse investors, and of a sovereign debt manager who takes fiscal policy as given. The model predicts that in countries where the exchange rate is countercyclical (i.e., the exchange rate depreciates during recessions), a more procyclical fiscal policy (i.e., expansionary in good times and contractionary in bad times) would lead, on average, to a more dollarized domestic sovereign debt. The empirical analysis using the Jeanne-Guscina EM Debt database (2006) on the currency structure of the central government debt in 22 emerging market countries over 1980 - 2005, supports these predictions.

Does Procyclical Fiscal Policy Reinforce Incentives to Dollarize Sovereign Debt?

This paper explores the link between the cyclical patterns of macroeconomic and policy variables and the currency composition of domestic sovereign debt in emerging market countries. The empirical analysis is anchored in an equilibrium model, in which the dollarization of sovereign debt arises as a result of the optimal portfolio choices by risk-averse investors, and of a sovereign debt manager who takes fiscal policy as given. The model predicts that in countries where the exchange rate is countercyclical (i.e., the exchange rate depreciates during recessions), a more procyclical fiscal policy (i.e., expansionary in good times and contractionary in bad times) would lead, on average, to a more dollarized domestic sovereign debt. The empirical analysis using the Jeanne-Guscina EM Debt database (2006) on the currency structure of the central government debt in 22 emerging market countries over 1980 - 2005, supports these predictions.

Renminbising China’s Foreign Assets

Since the 2008 global financial crisis, China has rolled out a number of initiatives to actively promote the international role of the renminbi and to denominate more of its international claims away from the US dollar and into the renminbi. This paper discusses the factors shaping the prospects of internationalising the renminbi from the perspective of the currency composition of China’s international assets and liabilities. These factors include, among others, underlying valuation and management of the renminbi.

Renminbising China's Foreign Assets

Since the 2008 global financial crisis, China has rolled out a number of initiatives to actively promote the international role of the renminbi and to denominate more of its international claims away from the US dollar and into the renminbi. This paper discusses the factors shaping the prospects of internationalising the renminbi from the perspective of the currency composition of China's international assets and liabilities. These factors include, among others, underlying valuation and management of the renminbi.