Embrace, don’t fear, slowing accumulation of EM FX Reserves

Much has been written about the apparent fall in emerging market (EM) central bank FX reserves since mid-2014 and the dire implications for developed equity and bond markets. I think this analysis misses three important points.

First, the focus on the USD-value of FX reserves ignores significant currency valuation effects – the US dollar’s appreciation versus other reserve currencies – and thus acutely exaggerates the actual fall in reserves.

Second, the slowdown in the pace of EM FX reserve accumulation partly reflects the gradual erosion of current account imbalances between EM and developed countries and EM central banks, particularly in Asia, allowing some currency appreciation. This is arguably a positive occurrence which developed country policy makers have called for.

Finally, the quantitative easing programs in advanced economies highlight their central banks’ willingness to supplement traditional sources of bond-buying.

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