The OMFIF Conversations: Foreign reserves in a volatile world
Central bank foreign exchange reserves around the world are likely to start growing again as emerging market economies rebuild currency ammunition to counter economic shocks and capital outflows, according to Gary Smith, Strategic Relationship Management Team: Sovereigns at Barings, and John Nugée, formerly Chief Manager of Reserves at the Bank of England. This was the key conclusion of a discussion accompanying the publication of the second report by Smith and Nugée for OMFIF on foreign exchange reserves management, ‘Foreign exchange reserves in a volatile world’.
Despite the decline in global foreign exchange reserves in the 18 months to the end of 2015, the trend of reserves accumulation by central banks over the preceding 15 years is unlikely to go into full reverse, say Smith and Nugée. Moreover, the experience of reserves shrinkage will raise the perception of what counts as adequate, both for those managing reserves and those commentating on their actions, leading to higher overall holdings in the future.
Nugée notes that expectations of the uses of reserves are also changing: ‘With multiple objectives for the reserves, central banks now have a choice between current use of reserves for the challenge of the moment, and preservation for future use. It has become legitimate, I think for the first time, for a central bank to put preservation of reserves as a higher objective than use of reserves in a crisis.’
Smith and Nugée conclude that, for all the inconveniences and costs of building large official foreign exchange holdings, these negative factors are outweighed by the still greater drawbacks of not holding sufficient reserves when they are needed in a financial or political crisis. As a result, the trend for reserves accumulation is unlikely to go into full reverse.
‘It’s a consequence of the world becoming more balanced between developed and developing countries,’ says Nugée. ‘Developing countries tend to need higher reserves per unit of GDP because their economies are less resilient and more volatile. As the developing countries take on the bigger share of world GDP, so the world begins to need a greater level of reserves to support a certain level of GDP. We’ve not seen the end of reserves accumulation.’
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