September 08, 2015

Hey, China and partners: are your international reserves adequate?

FX Reserves in China decreased by USD 94 b to USD 3,557 b in August, the highest   monthly fall on record, the biggest fall in percentage terms since May 2012. While falling commodity prices, several other emerging market and low income countries have experienced drains in their international reserves too.

Sensational headlines aside, what matters is assessing how adequate FX reserves are as a country insurance against external shocks.

Rules of thumb for measuring FX reserves levels adequacy have been in use for years. Best known among them are:
  • the 3-month import minimum as a cushion against foreign trade collapse; 
  • the short term one year residual debt, known as the Greenspan-Guidotti rule for mitigating the market access risk
  • the combination of both above plus the projected current account deficit, intended to reflect the full potential 12-month financing need;
  • the, also arbitrary, 20% of broad money (M2) as a proxy for protection against the risk of capital flight.

Some newer approaches include the cost of holding reserves into the picture, therefore changing the question from what is an adequate level to what is an optimal level for a country´s FX reserves. Unfortunately they are very dependent on stylized modeling assumptions and calibrations which jeopardize possibilities for their practical use.

The IMF developed a new methodology (2011, 2013) to assess reserves adequacy which suits the need of practioners very well. It built upon older measures by offering a metric which weights the different sources of FX reserve drains.

As if it were a risk weighted capital ratio for assessing a bank´s solvency, the IMF established a minimum, adequate level of precautionary FX reserves for a given country. Weights are suggested for Short term debt (STD), Portfolio Liabilities (OPL), Broad money (M2) and exports (X).

Since the exchange rate framework matters during an event of FX market pressure, weights are lower for countries under flexible exchange rate regimes.
IMF international reserves adequacy metric
Minimum expected outflows during exchange market pressure events

Fixed ER:   30% of STD + 15% of OPL + 10% of M2 + 10% of X

Floating ER:   30% of STD + 10% of OPL + 5% of M2 + 5% of X

The IMF suggests that the adequacy requirement is met as long a country’s reserves lie between 100-150% of the metric defined above

When applying the IMF benchmark to China, those now diminished current levels are still 32% above the estimated cushion to cope with exchange market pressure. Minimum adequate FX reserves would be USD 2,702 b.  

The same metric applied to a China-exposed emerging country like Chile results in a similar 30% comfort margin:  IMF-metric, USD 29.3b as compared to USD 38.1b of current international reserves.

Indeed, both China and Chile have access to IMF contingent credit facilities. They both also hold Sovereign Wealth Funds which are in part kept as precautionary reserves for macroeconomic stabilization purposes, so they could eventually provide extra liquidity should that be needed from outside their own central banks.

June 01, 2015

Here comes the Yuan

Last week our Central Bank in Chile signed a bilateral swap arrangement for RMB 22 billion with the People’s Bank of China (PBOC). This was the 31stamong similar agreements reached by the PBOC with other central banks - (total over RMB 3.1 trillion) - but it is the first in Latin America which has included a quota   for private qualified locals wanting to invest in RMB.

The PBOC policy of bilateral central bank swap arrangements would allow the building up of Renminbi deposits in foreign central banks. Those swap deposits, according to IMF guidelines, ‘are treated as reserve assets because the exchange provides the central bank with assets that can be used to meet the economy’s balance of payments financing needs and other related purposes’.

That is why countries suffering international reserves stress like Argentina have been active users PBOC facilities, favoring trade ties with China.

Indeed, neighboring Chile is in the financial behavior antipodes of Argentina in regard to FX adequacy and external solvency. Thus, the PBOC strategy has aimed far beyond relying on FX stressed trading partners. Its target is to become an international reserve currency.

So far, it is almost there. The use of the Renminbi in money market instruments in the Bank of International Settlements increased from US$0.9 million in the 3rd quarter of 2010 to 29.56 billion in the 2nd quarter of 2014. The Renminbi is already the seventh largest reserve currency. It ranks 9th in the amount outstanding of international debt securities (East Asia Forum, Feb. 2015).

Moreover, it is known that at least 23 central banks received qualified investor status, hold RMB assets - (and/or CNH, the “off shore RMB” that is) - as part of their international reserves:
The list comprises all geographies:
·                     Australia, Hong Kong, Indonesia, Japan, South Korea, Macau, Malaysia, Nepal, Pakistan, Singapore and Thailand
·                     Austria, Belarus, Norway, France and Lithuania
·                     Bolivia, Chile
·                     Ghana, Kenya, Nigeria, South Africa and Tanzania. 
Ultimately, the RMB should reach the SDR currency status during the IMF review due this year. This after the “freedom of use” criterion as it is comprised in the set of requirements for broadening the SDR basket currencies be met - (i.e. ‘widely used’ and ‘widely traded’ clauses are satisfied).

The RMB admission as a fifth SDR currency would further consolidate current central banks diversification, strengthening demand for RMB with potentially big portfolio reallocations, some RMB appreciation and less USD-RMB correlation over time.

We should welcome the new reserve currency since transactions costs, international trade and capital movements would benefit development from the SDR status. It would be desirable that the PBOC take this new status opportunity to improve transparency on its COFER reporting to the IMF, the currency composition of their own international reserves, that is.

January 15, 2015

More transparency needed on international reserves holdings

Data on the composition of foreign exchange reserves by central banks is unfortunately getting less transparent.

As the recently released COFER statistics show, an increasing proportion of international reserves holdings are reported as unallocated - (i.e. central banks chose not to deliver information on individual currency composition but only aggregate figures).

Consequently, we can only know the currency composition for 52.6% of the world´s international reserves, down from 55.8% in 2012 and well below 78.4% in 2000.

Reported currency composition and total international reserves


Q3 2012
Q3 2013
Q3 2014
Change 2012-14


% reported




% reported




% reported
Source: IMF

Unallocated reserves are mostly of emerging and developing countries origin. Since reserves grew the most at these countries, any persuasion effort towards more transparency should focus on them.

It is worthwhile to recall that transparency on foreign exchange reserves information is essential for keeping a sound sovereign credit standard. In particular, currency diversification is an important piece for any financial risk assessment. Currency risk opacity would do nothing to help a country´s credit worthiness.

A more active of the IMF in persuading country members to improve transparency and follow best practices on this matter would be needed.