FX RESERVES – ALL THINGS CONSIDERED EQUAL

There has been much scaremongering in the past year about on the one hand “currency wars” and on the other the decline in Emerging Market (EM) central bank FX reserves – the firepower policy-makers have to defend their currencies in the event of a sharp and/or prolonged sell-off.

A year ago I argued that market concerns about the level and direction of these FX reserves were overdone – see Embrace, don’t fear, slowing accumulation of EM FX reserves (7 April 2015) and Headline EM FX reserves distort the real story (2 June 2015). It has always struck me as somewhat ironic that for many years central banks were criticised for accumulating FX reserves and keeping their currencies artificially weak but markets are now fretting over a modest fall in reserves.

I reiterate my view that EM FX reserves remain sizeable despite their modest decline from a mid-2014 peak, particularly when currency-valuation effects are factored in (see Figure 1) and we look beyond China (see Figure 2) and commodity exporters. Based on partial data, FX reserves rose across the board in March, including by $10bn in China, on stronger global risk appetite and capital inflows. FX reserves are up from June 2014 in a number of sizeable Non-Japan Asia (NJA) economies, including India, Korea, Taiwan and Thailand.

While in aggregate EM FX reserves are still very large, the picture is differentiated at a country level. Reserves are considerable in NJA economies, bar Malaysia, India and particularly Indonesia, but are small in most of Latin America and in major African economies (including Egypt, Nigeria and South Africa). This is likely to continue influencing the ability and willingness of these countries’ central banks to slow, let alone stop, currency depreciation by intervening in the FX market (see Emerging Market currencies – don’t call this a comeback, 6 April 2016).

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