The size of currency reserves in emerging countries – a reliable indicator?

09:00 by Hubert Fromlet, Kalmar

Är valutareserven en pålitlig indikator för ekonomisk stabilitet på tillväxtmarknader?

Sammanfattning på svenska / Summary in Swedish

¤  Valutareservens storlek framstår inte nödvändigtvis som en pålitlig ekonomisk bedömnings- eller stabilitetsfaktor på en s k tillväxtmarknad (emerging market). Men det är givetvis bättre att valutareseven till exempel täcker tio månaders import än bara två månaders import. Emerging markets behöver normalt längre importtäckning genom valutareserven än etablerade OECD/EU-länder.

¤  En viktig indikation är också i vilken utsträckning valutareserven kan täcka eventuella bytesbalansunderskott och åtaganden från utlandsskulder. Graden av finansmarknadernas avreglering för gränsöverskridande kapitalrörelser kan dock utgöra ett viktigare analysinslag. China till exempel är i detta avseende fortfarande starkt reglerat. Vidare ger den tidsmässiga fördelningen av utlandsupplåningen (korta mot längre krediter) viktig information om behovet av utlandsvaluta inom överskådlig tid.

¤  Ibland kan också en välfylld valutareserv snabbt leda till valutabrist och en ohållbar situation. Så skedde exempelvis i Mexiko 1994, i Thailand och Malaysia 1997 samt i Lettland år 2008.


We still can note every month quite a number of comments on changes of the size of Chinese currency reserves (see my previous blog on – also when economically irrelevant changes happen by just a few billion dollars. Of course, the size of currency reserves of a country deserves analytical attention (but usually not so much in OECD/EU countries).

Why is that need? There may be quite a number of reasons. Let me in this context sum up five of the most important ones.

Motives for a reasonable size of currency reserves

¤ Currency reserves must cover (normal and necessary) imports by emerging markets for quite some time. However, the definition of “quite some time” may vary. Of course, I like ten months import coverage better than only two months coverage.

¤ Currency reserves are also an important indicator for the ability to serve foreign debt commitments. Necessary reserve volumes for this purpose depend to a high extent on the size of the foreign debt. Usually, I would like to see that commitments from foreign debt and the current account are covered at least a couple of quarters ahead. But such a time horizon cannot function as reliable guidance either. Therefore, foreign-debt structure (short term vs long term) and bond rate differentials vis-à-vis USD bonds may give other and better indications than combined numerical warning signals for foreign debt and the current account balance.

¤ Currency reserves can be used to intervene on forex markets – usually not officially announced or confirmed – when the own currency is considered as being too strong or sometimes even too weak by domestic decision-makers, usually coming from the political sphere.

¤ The important development of an emerging country’s current account is also linked to the size of the currency reserves. However, deficits in the current account can only be financed in four ways,

  • by receiving foreign direct investments (FDI) -> usually the best way,
  • by borrowing money abroad -> with obvious limitations,
  • by selling treasury bills, bonds and stocks to other countries -> risky,
  • by reducing the currency reserves -> a very limited possibility.

¤ A relatively high level of currency reserves may also serve as a psychological indicator for economic and financial strength. This kind of function is certainly much more important in emerging countries than in advanced and at the same time well-working economies.

What is sufficient?

Unfortunately, there are no clear thumb rules about necessary currency volumes that may be high enough to have sufficient protection against a potential future economic and/or financial crisis. The mood of global financial markets may differ from time to time, and so may the quality of the government in the affected emerging market. Variations may also show up when it comes to contagion risks to other countries, to the GDP-growth situation in the global economy or to an emerging country’s ongoing deregulation process of the capital account.

Altogether we should keep in mind that no safe prediction can be made about the sufficiently secure size of currency reserves in emerging markets. Mexico in 1994, Thailand and Malaysia in 1997and also Latvia in 2008 seemed to be on the safe side with the size of their pre-crisis levels of the currency reserves. However, developments became suddenly very stormy – and they derailed then very rapidly.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University
Editorial board


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