FX Reserves Research Articles

Term spread spillovers to Latin America and emergence of the ‘Twin Ds’

This paper investigates the relationship between depreciation and default risks in five key Latin American markets—Brazil, Chile, Colombia, Peru, and Mexico—in response to shifts in the US yield curve slope. Excluding serial defaulters like Argentina, our focus lies on countries still susceptible to the Twin Ds phenomenon amidst high debt levels. We find that global economic spillovers significantly influence the Twin Ds in these markets; with fluctuations in the US term spread serving as an indicator of broader shifts in global economic conditions. Our analysis reveals asymmetric spillover effects, particularly during periods of positive and increasing spreads such as the Global Financial Crisis, where changes in the term spread disproportionately impact the depreciation tail in currency markets and the high-risk tail in sovereign CDS markets. Notably, such effects are absent in stock markets, which accentuate the particular dynamics of currency and sovereign debt markets. The asymmetry of spillover effects although still present during the most recent Covid-19 crisis, was less pronounced, which may be linked to the accumulation of international FX reserves in the region during the last decades. Our findings emphasize the necessity of incorporating risk spillovers into policy frameworks, highlighting the dominance of risk spillovers over price spillovers and the obscured nature of shocks at the center of the variables’ distribution.

Risk preferences, global market conditions and foreign debt: Is there any role for the currency composition of FX reserves?

I estimate a transition probability matrix associated with a two-state Markov process of emerging market economies (EMEs) volatility. The different states of EMEs volatility, generate switches in central bank preferences between approximated constant relative risk aversion and increasing relative risk aversion expected utility. Therefore, I construct and propose constrained portfolio selection frameworks with skewness, for the currency composition of FX reserves over different EMEs volatility states for Brazil, Indonesia and South Africa. These EMEs have constituted as part of the “Fragile Five”. Thus, I propose progressive risk management procedures for these EMEs. These portfolio selection frameworks satisfy Pratt–Arrow measures of risk aversion and are constrained by each country’s currency composition of foreign debt. Using different methods of computing expected FX reserves returns, traditional strategic FX reserve assets and different maturity structures, I simulate optimal FX reserve weights for each EME and validate my proposal.

Effects of Government Expenditure on Foreign Exchange Reserves: Evidence for Namibia

The study empirically investigated the effects of government expenditure on FX reserves in Namibia. Using quarterly data, the study applied the Autoregressive Distributed Lag (ARDL) cointegration technique to examine the relationship between FX reserves and government expenditure, the exchange rate, external borrowing, current account balance and M2 over the period ranging from 2002 to 2020. The results show that an increase in government expenditure reduces FX reserves. Furthermore, increase in foreign debt, current account balance and M2 increases the level of FX reserves, while an appreciation of the effective exchange rate reduces FX reserves. The study, therefore, concludes that high government expenditure and increase in foreign borrowing impacts FX reserves. These findings suggest that developments in government expenditure may hinder monetary policy effectiveness. Based on these findings, the study recommends the continuation of fiscal consolidation to reduce fiscal deficits and government debt. Similarly, it is important to ensure macroeconomic balance and appropriate coordination between fiscal and monetary policies.

Geopolitics and the U.S. Dollar's Future as a Reserve Currency

I survey the role of geopolitics and sanctions risk in shaping the U.S. dollar's status as the primary currency used for international reserves. Without changes in the economic incentives for holding FX reserves in U.S. dollar assets, an increased threat of sanctions is unlikely to drastically reduce the dollar share of FX reserves. Currently, around three-quarters of foreign government holdings of safe U.S. assets are by countries with some military tie to the U.S. Even a reduced reliance on the U.S. dollar for trade invoicing and debt denomination by a large bloc of countries less geopolitically aligned with the U.S. would be unlikely to end U.S. dollar dominance.

Ukraine

The Russian invasion of Ukraine that started over seven months ago has caused large loss of life, large population displacement, and significant infrastructure damage. The impact on economic activity has been enormous: real GDP has severely contracted, inflation has risen sharply, trade has been significantly disrupted, and the fiscal deficit has ballooned to unprecedented levels. In the immediate aftermath of the invasion, the authorities quickly adapted monetary and exchange rate policies to preserve financial and exchange rate stability. More recently, and to help reverse significant international reserves loss, the exchange rate was devalued, helping to stabilize FX reserves and maintain overall macroeconomic and financial stability. Fiscal policy has been geared to priority spending on defense, social benefits, humanitarian needs, and where possible some fixing of critical infrastructure. Uncertainty around the size of financing needs remains extremely elevated and highly dependent on the length of the war and its intensity, and economic risks loom large, including those related to potential additional damage to critical infrastructure or new disruptions to the agricultural and energy sectors.

Impact of Reserve Option Mechanism on Exchange Rate Volatility During the FED’s Tapering Period

Abstract This study investigates the effectiveness of ROM. We conducted the GARCH (1,1) Model to determine whether ROM contributed to decreasing the volatility of USD/TL exchange rate for the period 2013-2014. We construct four Models where four different variables are separately used that represent the ROM tool, i.e. the amount of FX reserves of CBRT via ROM, and the share of the FX reserves via ROM in Gross FX Reserves of CBRT. Our findings are convincing to say FX facility and the ratio of utilization for the FX facility to ensure the results are statistically meaningful during this period.

Winds of tapering, financial gravity and COVID-19

Real interest rates have fallen dramatically since the early 1980s. Economic theory states that lower real rates discourage savings while promoting spending. However, today, in the world economy, we face a global saving glut problem in which, even in negative real rates, economic agents keep saving. This situation leads to excess demand for safe assets (US Treasuries), lower bond yields, and higher equity valuations. Thus, the world economy has become more dependent on major economies, especially the United States. In this research, we aim to measure the dependency of the world economy on United States monetary policy. We called this new methodology “financial gravity” and tried to quantify the nature by using panel data analysis. We define monetary dependency (financial gravity) by US Investment flows and their reaction against International Reserves, Credit Default Spreads (CDS), and Foreign Exchange Rates. Our empirical findings support that financial gravity is positively related to international reserves and negatively related to Credit Default Swap Spreads (CDS) and Foreign Exchange rates. We also analyzed the COVID-19 period and found that pandemics positively contributed to world reserve accumulation due to economic lock-down measures, fiscal stimulus packages (unemployment benefits), and decreased global spending.

UKRAINE’S MONETARY POLICY EFFECTIVENESS UNDER WAR

Introduction. Notwithstanding the Ukrainian banking system's resilience under war, there are devaluation and inflation pressures. In turn, monetary policy is found to be vital to combat drastic GDP decline and FX reserve depletion. Materials and methods. In an attempt to examine the effectiveness of the NBU's (National bank of Ukraine) monetary policy, the article employs comparative and statistical analysis of its instruments based on data regarding dynamics of key and other interest rates (deposits, loans, certificate of deposits, refinancing, DGBs), volumes of foreign exchange interventions and international reserves, DGBs. Results and discussion. This paper summarises the fundamental changes in monetary policy since the beginning of the full-scale war. The findings demonstrate a shift from the policy priority of inflation targeting and a freely floating exchange rate in favour of monetary financing of the budget deficit. At the same time, the devaluation of the national currency is restrained mainly at the expense of international credit and grant funds, which makes it possible to cover the losses of the NBU's FX reserves to support the exchange rate and carry out additional money issuance. The results show that under the war, the NBU's monetary policy is effective in limiting devaluation processes due to the timely introduction of a fixed exchange rate, strengthening of currency restrictions and their further adjustment. However, due to the increase in the discount rate and the corresponding increase in interest rates on certificates of deposit and refinancing and a slight increase in deposits, DGBs did not restrain inflation due to the lack of alternative monetary financing of the budget deficit. Further focus exclusively on the inflation targeting regime does not meet the current tasks of monetary policy and thereby reduces its effectiveness. The current budget dependence on monetary financing requires optimising monetary expansion measures in order to flow the issuing money from the military to the consumer market. Conclusions. The effectiveness of inflation targeting with limited monetary policy transmission indicates that the NBU should focus on other goals equally crucial to maintaining price stability, such as limiting exchange rate fluctuations and monetary financing for economic growth. In post-war recovery, the monetary policy direction solely on inflation targeting will remain inappropriate, given the mainly non-monetary factors of inflation.

Do central banks rebalance their currency shares?

Do central banks rebalance their currency shares? The answer matters because the dollar’s predominant role in large official reserve holdings means that widespread rebalancing requires central banks to buy (sell) a depreciating (appreciating) dollar, stabilising its value against other major currencies. We hypothesise that larger reserve holdings have led central banks to approach their investment more systematically and to make rebalancing in the face of exchange rate changes the norm. We illustrate the choice with two polar case studies: the US clearly does not rebalance its small FX reserves; Switzerland does rebalance its very large reserves, so that changes in exchange rates do not move its currency allocation. Our hypothesis finds partial support in global aggregated data. They reject both no rebalancing and full rebalancing and point to emerging market economies as the source of the aggregate result. We also test for rebalancing with panel data and find that our sample economies on average again behave in intermediate fashion, partially but not fully rebalancing. However, when observations are weighted by the size of reserves, the panel analysis finds full rebalancing. A variety of control variables and splits of the panel sample do not alter the thrust of these findings. Central banks rebalance their FX reserves extensively but not uniformly.

Endogenous corporate leverage response to a safer macro environment: The case of foreign exchange reserve accumulation

A country may adopt policy measures such as raising its foreign exchange reserves to better prepare for sudden reversal of international capital flows or currency attacks, which in principle should reduce financial vulnerability for its firms and the entire economy, but the beneficial effect of such policies may be partially offset by endogenous firms' decisions to take on more risks. We present a robust but previously undocumented relationship between corporate leverage and country-level foreign exchange reserve holdings. For 6610 non-financial firms in 23 emerging markets from 2000 to 2006, we show that more foreign reserve accumulation leads to higher corporate leverage. The effect is significantly greater in sectors that are intrinsically more sensitive to uncertainty. We go from correlation to causality via a two-prong instrumental variable strategy: simultaneously (1) instrumenting FX reserves by global commodity price movement, and (2) examining leverage of firms outside the commodity-sensitive sectors.

Do Central Banks Rebalance Their Currency Shares?

Do central banks rebalance their currency shares? The answer matters because the dollar’s predominant role in large official reserve holdings means that widespread rebalancing requires central banks to buy (sell) a depreciating (appreciating) dollar, stabilising its value against other major currencies. We hypothesise that larger reserve holdings have led central banks to approach their investment more systematically and to make rebalancing in the face of exchange rate changes the norm. We illustrate the choice with two polar case studies: the US clearly does not rebalance its small FX reserves; Switzerland does rebalance its very large reserves, so that changes in exchange rates do not move its currency allocation. Our hypothesis finds partial support in global aggregated data. They reject both no rebalancing and full rebalancing and point to emerging market economies as the source of the aggregate result. We also test for rebalancing with panel data and find that our sample economies on average again behave in intermediate fashion, partially but not fully rebalancing. However, when observations are weighted by the size of reserves, the panel analysis finds full rebalancing. A variety of control variables and splits of the panel sample do not alter the thrust of these findings. Central banks rebalance their FX reserves extensively but not uniformly. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Surging bond yields and fiscal crisis remain unlikely

▀ We expect core government bond yields to trend upwards over the next five years, but based on our modelling work, a big surge in yields looks unlikely. Even our most downbeat scenario implies only moderate rises in debt service costs, suggesting governments will be relaxed about rising yields. ▀ Core government bond yields have been low for over a decade, helped by excess global demand for certain government bonds seen as “safe assets.” But there are historical examples of yields surging after long periods during which they've been low and steady, such as in the US in the 1960s‐1970s. ▀ We ran a series of model scenarios that simulate the impact of factors such as a sharp rise in government debt, curtailed QE, reduced demand for core currencies as FX reserves, and higher inflation. Individual shocks to supply and demand for these safe assets add an extra 14bps‐70bps to yields. A combined shock adds an extra 130bps to US 10‐year yields by 2025, going to 3.5% from our baseline of 2.2% and 0.9% currently. ▀ The rises in yields generated in our scenarios look small by historical standards, although they would imply quite large price changes in bonds given the low starting level of yields. Some of the individual shocks could result in investors suffering losses similar to those in 1994 or 2013–2014. In the combined negative scenario, losses could approach those seen in 1965–1970. ▀ Rising bond yields feed into higher government debt service costs only gradually, especially when average debt maturity is long. As a result, most governments are likely to be quite relaxed about rising yields, and these should not be a big barrier to continued loose fiscal settings. Investors cannot rely on the reimposition of austerity to help limit their downside this time around.

A novel approach to the estimation of an actively managed component of foreign exchange reserves

This paper offers a novel approach to the estimation of an active component of reserves making use of a time-varying coefficient model estimated with Bayesian techniques. The approach substantially extends the time and country coverage of estimates beyond that available under the existing approach. We find that the estimates of an active component for 20 countries over 1995–2017 period are highly correlated with those obtained from the existing approach. The new estimates are cross-checked against the available data on FX market interventions in Argentina, Chile, the Czech Republic, Mexico, Russia and Turkey. We demonstrate that these estimates are a better proxy of FX interventions than simple changes in reserves and are at least as good as the estimates from the existing approach. Our novel approach contributes to a better understanding of changes in FX reserves in many countries, including large reserve holders for which the relevant data are hardly available.

Limiting risk premia in EMEs: The role of FX reserves

Low debt and inflation, and higher growth reduce default risk. FX reserves do not matter for risk whenever CDS spreads are below the median. But higher FX buffers clearly reduce risk at the higher end of the sovereign risk spectrum.

Limiting Risk Premia in EMEs: The Role of FX Reserves

Sovereign risk premia have declined for the majority of emerging market economies. This paper analyzes the key drivers of risk premia, as proxied by the 5-year CDS spreads, using a quantile regression approach. We find that lower public debt and inflation, as well as higher growth are key to reducing perceived default risk. FX reserves do not generally matter for risk whenever CDS spreads are below the median level. But higher FX buffers clearly do reduce perceived risk in a significant way whenever one moves to the higher end of the sovereign risk spectrum.

Why ‘King dollar’ is reigning supreme

▀ After a pause in late 2017 and early 2018, the dollar has resumed its rise. Our analysis suggests the long‐term factors influencing the dollar are likely to remain supportive in 2020, ebbing only in 2021. ▀ Alongside positive interest rate differentials, several key factors explain the recent dollar strength including relatively strong economic growth, a contained external deficit and significant equity market outperformance. ▀ Over 2018–2019 US growth has been faster than the rest of the G7, which suffered more downside surprises this year. Meanwhile, the deterioration in the US external deficit was less than expected, despite the Trump fiscal stimulus. ▀ The massive improvement in the US oil balance over recent years looks like an important long‐term structural support for the dollar. It allows the US to grow faster and have a stronger currency than would otherwise have been the case. ▀ The dollar is also supported by its still‐dominant position in global financial markets. Recent talk of ‘de‐dollarisation’ looks to be largely hype ‐ the dollar's share of cross‐border transactions, trade invoicing, and FX reserves is high and either stable or rising. ▀ The conditions necessary to create another dollar bear market like that in 2002–2008 may be hard to reproduce. A period of relative underperformance in US stocks is conceivable, but the 2002–2008 period also featured large US basic balance of payments deficits and persistently negative long‐term real yield differentials, which look less likely to materialise.

Jamaica

The 3-year Stand-By Arrangement (SBA) terminates shortly after conclusion of this sixth and final review. As Jamaica graduates from 6½ years of continuous Fundsupported reform programs over two successive arrangements, macroeconomic stability has been entrenched with substantial fiscal over-performance and efforts to address structural weaknesses. Public debt has been significantly reduced, unemployment is at a historic low, credit recovery is gaining force on the back of substantial monetary easing, FX reserves are comfortable, and inflation is subdued. However, for most of the past 6 years, growth has been low. The authorities are committed to policy continuity, safeguarding the hard-earned economic gains, and promoting growth and job creation.

Does sovereign risk in local and foreign currency differ?

Sovereign debt in local currency has been considered safer than in foreign currency. The literature offers scant guidance as to why such a gap existed, or why it has slowly and steadily diminished over the past two decades. We suggest and empirically test five hypotheses. We find FX reserves, and original sin (greater financing in local currency) to consistently be robust determinants of the gaps in local and foreign currency ratings. As for why the gap has declined, we identify as important factors the surge in global reserves, and to a lesser extent the decline of original sin.

Macroeconomic Factors as a Predictor of Stock Market: Empirical Evidences from India, U.S. and U.K.

The study investigated the impact of Macroeconomic variables such as: Gross Domestic Product (GDP), The Index of Industrial Production (IIP), Consumer Price Index (CPI), Foreign-exchange reserves (also called forex reserves or FX reserves), International Crude Price (CP) on selected stock market, namely Indian Stock Market (S&P BSE SENSEX (BSE 30) index, S&P CNX Nifty index (NIFTY 50), London Stock Exchange (Financial Times Stock Exchange 100 Index (FTSE 100) and New York Stock Exchange Dow Jones Industrial Average (Dow 30). The data sets of all variables have been considered from April, 2001 to March, 2018 on a monthly basis. The study reveals long run relationship among the variables and the results of Granger Causality test reveals unidirectional, bilateral relation (Feedback) and exogeneity (Independence) among the variables.

On the Increased FX Reserves and the Decreased Funds Outstanding for FX in China from 2014 to 2017

Objectives: This study focuses on the off-normal occurrence between the increased FX reserves and the decreased Funds Outstanding for FX in China after 8.11 exchange rate reforms, and discusses the inducement induced between the decrease of ESS of Commercial Banks and the increased FX reserves. Methods/Statistical Analysis: This study uses the data of HIBOR and SHIBOR, the data of Spot and NDF from 2014-2017 as independent variables, approach the correlation between ESS and the four factors above by Grainger Causality Test, and then by the VAR Modal for re-test. Discusses the reason based on the reality. Findings: This study finding is that the expectations for RMB exchange rate leads to the currency hedging, which is also the reason for the ESS deficit. But this result can’t give an answer to the increased FX reserves for that time. Application/Improvements: This study explores the incentives why the banking settlement and sale transferred from surplus to deficit based on the data of banking settlement and sale, the interest rate data of SHIBOR and HIBOR, the exchange rate data of Spot onshore and NDF offshore from 2014 to 2017, and demonstrate such a statement that \