More from For a Few Dollars More: Reserve Accumulation in Times of Crisis, by Matthieu Bussiere (Banque de France), Menzie Chinn (UW), Gong Cheng (Sciences Po), Noemie Lisack (European University Institute) (also NBER Working Paper No. 19791):
…In the immediate aftermath of the crisis, countries that depleted foreign reserves during the crisis quickly rebuilt their stocks. This rapid rebuilding has, however, been followed by a deceleration in the pace of accumulation. The timing of this deceleration roughly coincides with the point when reserves reached their pre-crisis level and may be related to the fact that short-term debt accumulation has also decelerated in most countries over this period.
Note that the characterization applies to a ratio — specifically the log ratio of reserves to short-term debt, rather than reserves specifically.
First consider the evolution of the level of reserves, for non-advanced economies as categorized by the IMF, and China:
Figure 1: Foreign exchange reserves of emerging market economies and less developed countries (blue), and international reserves ex.-gold for China (red). Dashed line at 2008Q3. Source: IMF COFER, and IMF IFS via FRED.
Second, as we argue in the paper, the (log) ratio of reserves-to-short term debt seems to be a key explanatory variable for growth during crisis the stabilization in terms of the log-ratio is even more pronounced.
A ‘flattening-out’ of foreign reserve accumulation is also noticeable in other countries when a more recent period is considered. This is the case for Indonesia, Malaysia and Thailand (figure 9) and many East European countries (figure 10) from the end of 2010. What drives this ‘flattening’ in foreign reserve accumulation? We come up with several possible explanations. First, it is possible that, once a country reached its pre-crisis level of reserves, it slows down the accumulation as foreign reserves are no free lunch and the opportunity cost and risks associated with valuation effects may be high. Second, the deceleration of foreign reserve accumulation may reflect a change of policy priority with regard to monetary autonomy, exchange rate stability and financial openness in the wake of the 2008-2009 financial crisis, as Aizenman et al. (2010) put forward. After all, reserve accumulation may be motivated by the need to reconcile the ‘Impossible Trinity’ (this is however an aspect of reserve accumulation that we do not consider in this paper). Last but not least, if foreign reserve accumulation tails off, it might be because of the stabilization of the underlying macroeconomic variable that foreign reserves are used to cover. In our paper, we argue that this macroeconomic variable is short-term debt. With the ‘flattening-out’ of short-term debt after the financial crisis (the reasons why short-term debt diminishes after the GFC are multiple, e.g. Great Retrenchment), the demand for foreign reserves must fall.
Figure 8 from the paper highlights the general pattern for the BRICs plus, at least in the sample examined (the sample ends earlier in the paper, matching the availability at time of writing of short term debt used to construct the ratio).
Figure 8 from Bussière, Cheng, Chinn and Lisack.
For these countries, the ratio has plateaued. China is one notable exception. (However, since the end of the graph’s sample, Chinese reserves level did stabilize, with a resumption of slower growth in 2013.)