Strengthening the global financial safety net
CENTRAL BANKS ENTERED the Covid-19 pandemic with a higher level of collective foreign exchange reserves than in the run-up to all previous financial crises. Central bank foreign exchange reserves, which include gold, have increased steadily over the past decade, rising to $15.3tn at the end of 2020 from $12.1tn in 2016. The Covid-19 crisis tested the use and effectiveness of these reserves. Central banks are motivated to engage in capital flow management and potentially draw down foreign exchange reserves when they need to:
• Access foreign currencies to provide import cover and provide liquidity to dependent companies
• Support the value of the exchange rate if the central bank has a target
• Manage debt sustainability in the face of high levels of foreign currency-denominated debt.
These conditions were scrutinised during the Covid-19 crisis and several central banks – particularly from emerging markets – intensified foreign exchange interventions. According to the Organisation for Economic Cooperation and Development, such interventions reached ‘magnitudes comparable to those of the 2008 crisis, amid considerable turbulence and volatility in the foreign exchange market.’