Foreign exchange reserves
Foreign exchange reserves (also called Forex
reserves) in a strict sense are only the foreign currency deposits and bonds
held by central banks and monetary authorities. However, the term in popular
usage commonly includes foreign exchange and gold, SDRs and IMF reserve
positions. This broader figure is more readily available, but it is more
accurately termed official international reserves or international reserves.
These are assets of the central bank held in different reserve currencies,
mostly the US dollar, and to a lesser extent the euro, the UK pound, and the
Japanese yen, and used to back its liabilities, e.g. the local currency issued,
and the various bank reserves deposited with the central bank, by the government
or financial institutions.
History
Official international reserves, the means of official international payments,
formerly consisted only of gold, and occasionally silver. But under the Bretton
Woods system, the US dollar functioned as a reserve currency, so it too became
part of a nation's official international reserve assets. From 1944-1968, the US
dollar was convertible into gold through the Federal Reserve System, but after
1968 only central banks could convert dollars into gold from official gold
reserves, and after 1973 no individual or institution could convert US dollars
into gold from official gold reserves. Since 1973, no major currencies have been
convertible into gold from official gold reserves. Individuals and institutions
must now buy gold in private markets, just like other commodities. Even though
US dollars and other currencies are no longer convertible into gold from
official gold reserves, they still can function as official international
reserves.
[3-2-2008.com ] Purpose
In a flexible exchange rate system, official international reserve assets allow
a central bank to purchase the domestic currency, which is considered a
liability for the central bank (since it prints the money itself as IOUs). This
action can stabilise the value of the domestic currency.
Central banks throughout the world have sometimes cooperated in buying and
selling official international reserves to attempt to influence exchange rates.
[3-2-2008.com ] Changes in reserves
The quantity of foreign exchange reserves can change as a central bank
implements monetary policy. A central bank that implements a fixed exchange rate
policy may face a situation where supply and demand would tend to push the value
of the currency lower or higher (an increase in demand for the currency would
tend to push its value higher, and a decrease lower). In a flexible exchange
rate regime, these operations occur automatically, with the central bank
clearing any excess demand or supply by purchasing or selling the foreign
currency. Mixed exchange rate regimes ('dirty floats', target bands or similar
variations) may require the use of foreign exchange operations (sterilized or
unsterilized[clarification needed]) to maintain the targeted exchange rate
within the prescribed limits (China has been repeatedly accused of doing this by
the USA).
Foreign exchange operations that are unsterilized will cause an expansion or
contraction in the amount of domestic currency in circulation, and hence
directly affect monetary policy and inflation: An exchange rate target cannot be
independent of an inflation target. Countries that do not target a specific
exchange rate are said to have a floating exchange rate, and allow the market to
set the exchange rate; for countries with floating exchange rates, other
instruments of monetary policy are generally preferred and they may limit the
type and amount of foreign exchange interventions. Even those central banks that
strictly limit foreign exchange interventions, however, often recognize that
currency markets can be volatile and may intervene to counter disruptive
short-term movements.
To maintain the same exchange rate if there is increased demand, the central
bank can issue more of the domestic currency and purchase the foreign currency,
which will increase the sum of foreign reserves. In this case, the currency's
value is being held down; since (if there is no sterilization) the domestic
money supply is increasing (money is being 'printed'), this may provoke domestic
inflation (the value of the domestic currency falls relative to the value of
goods and services).
Since the amount of foreign reserves available to defend a weak currency (a
currency in low demand) is limited, a foreign exchange crisis or devaluation
could be the end result. For a currency in very high and rising demand, foreign
exchange reserves can theoretically be continuously accumulated, although
eventually the increased domestic money supply will result in inflation and
reduce the demand for the domestic currency (as its value relative to goods and
services falls). In practice, some central banks, through open market operations
aimed at preventing their currency from appreciating, can at the same time build
substantial reserves.
In practice, few central banks or currency regimes operate on such a simplistic
level, and numerous other factors (domestic demand, production and productivity,
imports and exports, relative prices of goods and services, etc) will affect the
eventual outcome. As certain impacts (such as inflation) can take many months or
even years to become evident, changes in foreign reserves and currency values in
the short term may be quite large as different markets react to imperfect data.
[3-2-2008.com ] Costs, benefits, and criticisms
Large reserves of foreign currency allow a government to manipulate exchange
rates - usually to stabilize the foreign exchange rates to provide a more
favorable economic environment. In theory the manipulation of foreign currency
exchange rates can provide the stability that a gold standard provides, but in
practice this has not been the case.
There are costs in maintaining large currency reserves. Fluctuations in exchange
markets result in gains and losses in the purchasing power of reserves. Even in
the absence of a currency crisis, fluctuations can result in huge losses. For
example, China holds huge U.S. dollar-denominated assets, but the U.S. dollar
has been weakening on the exchange markets, resulting in a relative loss of
wealth. In addition to fluctuations in exchange rates, the purchasing power of
fiat money decreases constantly due to devaluation through inflation. Therefore,
a central bank must continually increase the amount of its reserves to maintain
the same power to manipulate exchange rates. Reserves of foreign currency
provide a small return in interest. However, this may be less than the reduction
in purchasing power of that currency over the same period of time due to
inflation, effectively resulting in a negative return known as the "quasi-fiscal
cost". In addition, large currency reserves could have been invested in higher
yielding assets.
[3-2-2008.com ] Excess reserves
Foreign exchange reserves are important indicators of ability to repay foreign
debt and for currency defense, and are used to determine credit ratings of
nations, however, other government funds that are counted as liquid assets that
can be applied to liabilities in times of crisis include stabilization funds,
otherwise known as sovereign wealth funds. If those were included, Norway and
Persian Gulf States would rank higher on these lists, and UAE's $1.3 trillion
Abu Dhabi Investment Authority would be second after China. Singapore also has
significant government funds including Temasek Holdings and GIC. India is also
planning to create its own investment firm from its foreign exchange reserves.
[3-2-2008.com ] Levels
Reserves of foreign exchange and gold in 2006See also: List of countries by
foreign exchange reserves
At the end of 2007, 63.90% of the identified official foreign exchange reserves
in the world were held in United States dollars and 26.5% in euros [1].
Monetary Authorities with the largest foreign reserves in 2008.
Rank Country/Monetary Authority billion USD (end of month) change in year 2007
1 People's Republic of China $ 1953 (Mar 2009) 1[1] +32.9%
2 Japan $ 1019 (Mar 2009) +8.7%
- Eurozone $ 531 (Feb 2009) +16.6%
3 Russia $ 413 (June 2009) 2 [2] ▲
4 Taiwan $ 305 (Apr 2009) [3] +2.7%
5 India $ 262 (June 2009) 2 [4] +64.4%
6 South Korea $ 232 (Jun 2009) ▲
7 Brazil $ 206 (Jun 2009) 3 +105.9%
8 Hong Kong $ 186 (Mar 2009) +14.6%
9 Singapore $ 166 (Mar 2009) +19.1%
10 Germany $ 144 (Feb 2009) -
Note:
Note 1: China updates its information quarterly.
Note 2: Russia and India update their information weekly and monthly.
Note 3: Brazil updates its information daily.
These few holders account for more than 60% of total world foreign currency
reserves. The adequacy of the foreign exchange reserves is more often expressed
not as an absolute level, but as a percentage of short-term foreign debt, money
supply, or average monthly imports.
[3-2-2008.com ] References
^ http://www.bloomberg.com/apps/news?pid=20601080&sid=aox4QuXXNghM&refer=asia
^ "Foreign exchange reserves, Central Bank of Russia.".
http://www.cbr.ru/eng/statistics/print.aspx?file=credit_statistics/inter_res_09_e.htm.
^ "Key indicators, The Central Bank of the Republic of China.".
http://www.cbc.gov.tw/EngHome/default.asp. Retrieved on 2009-05-05.
^ "Reserve Bank of India".
http://timesofindia.indiatimes.com/Business/Indias-forex-reserves-at-262306bn/articleshow/4622264.cms.