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The Accumulation of Foreign Reserves

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The Accumulation of Foreign Reserves A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics International Relations Committee Task Force Research Report The accumulation of foreign reserves ECB Occasional Paper, No. 43 Provided in Cooperation with: European Central Bank (ECB) Suggested Citation: International Relations Committee Task Force (2006) : The accumulation of foreign reserves, ECB Occasional Paper, No. 43, European Central Bank (ECB), Frankfurt a. M. This Version is available at: http://hdl.handle.net/10419/154496 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu OCCASIONAL PAPER SERIES NO. 43 / FEBRUARY 2006 THE ACCUMULATION OF FOREIGN RESERVES by an International Relations Committee Task Force OCCASIONAL PAPER SERIES NO. 43 / FEBRUARY 2006 THE ACCUMULATION OF FOREIGN RESERVES by an International Relations Committee Task Force * In 2006 all ECB publications will feature This paper can be downloaded without charge from a motif taken http://www.ecb.int or from the Social Science Research Network from the €5 banknote. electronic library at http://ssrn.com/abstract_id=807417. * The opinions expressed in this paper are those of the authors listed on page 6 and do not necessarily reflect those of the European Central Bank or the national central banks that the authors are affiliated with. © European Central Bank, 2006 Address Kaiserstrasse 29 60311 Frankfurt am Main Germany Postal address Postfach 16 03 19 60066 Frankfurt am Main Germany Telephone +49 69 1344 0 Website http://www.ecb.int Fax +49 69 1344 6000 Telex 411 144 ecb d All rights reserved. Any reproduction, publication and reprint in the form of a different publication, whether printed or produced electronically, in whole or in part, is permitted only with the explicit written authorisation of the ECB or the author(s). The views expressed in this paper do not necessarily reflect those of the European Central Bank. ISSN 1607-1484 (print) ISSN 1725-6534 (online) CONTENTS PREFACE 6 ANNEX 3 RISKS TO AND CHALLENGES FOR THE CONDUCT MEMBERS OF THE INTERNATIONAL RELATIONS OF MONETARY POLICY 37 COMMITTEE TASK FORCE ON ACCUMULATION 1 Background 37 OF FOREIGN RESERVES 7 2 Institutional characteristics and monetary policy responses in SUMMARY 8 some major reserve-accumulating 1 The puzzle of reserve accumulation economies 38 since 2002 9 2 Possible drivers of the recent ANNEX 4 reserve accumulation 13 THE FOREIGN POSITIONS OF SEVEN ASIAN 3 Domestic risks and costs of CENTRAL BANKS: reserve accumulation 17 TRENDS AND POTENTIAL RISKS 40 4 Main trends in central bank 1 Background 40 reserve management 19 2 Trends in the net foreign position 5 Alternative uses of accumulated of seven Asian central banks 41 foreign assets 23 3 Potential costs of net foreign asset 6 Impact on yields and asset prices 24 holdings 42 4 Institutional arrangements related to the management of foreign currency ANNEXES reserves 44 ANNEX 1 ANNEX 5 STYLISED FACTS OF THE ACCUMULATION OF DEVELOPMENTS IN CENTRAL BANK FOREIGN EXCHANGE RESERVES 27 RESERVE MANAGEMENT AND THEIR POSSIBLE MARKET IMPLICATIONS 46 1 Individual countries and regions 27 1 Background 46 2 Reserves channelled into oil and heritage funds 28 2 Main trends in reserve management since 1999: diversification, but to ANNEX 2 what extent? 47 MAIN DRIVERS OF RESERVE ACCUMULATION: 3 The coexistence of various foreign A REVIEW OF THE LITERATURE 29 reserve management frameworks 51 1 Background 29 4 US and euro area fixed income 2 Precautionary motives 30 markets: can differences limit currency diversification? 51 3 The “global savings glut” 34 5 Market implications of excessive 4 Management of exchange rates 35 foreign reserve accumulation in 5 Costs of managing exchange rates, terms of possible distortions of and “socialisation” of exchange current bond market dynamics 55 rate risk 35 6 Unconventional monetary policies 36 ECB Occasional Paper No. 43 February 2006 3 ANNEX 6 THE IMPACT OF ASIAN RESERVE ACCUMULATION ON ASSET PRICES 55 1 Background 55 2 The role of changes in the relative supply of Treasuries on yields: A review of available evidence 56 3 A model to explain the impact of Asian reserve accumulation on ten-year Treasury yields 57 4 A model to explain the impact of Asian reserve accumulation on three-year Treasury yields 59 5 Impact on other asset prices 61 ANNEX 7 THE FINANCING OF THE US CURRENT ACCOUNT DEFICIT: A SHORT REVIEW OF THE LITERATURE AND SOME EVIDENCE 63 1 Background 63 2 Review of the literature, and links with current policy issues 64 3 A descriptive analysis of US current account deficit financing 66 REFERENCES 68 LIST OF OCCASIONAL PAPERS 74 ECB Occasional Paper No. 43 4 February 2006 PREFACE PREFACE The report – on which this occasional paper is based1 – was discussed by the IRC in June In a number of countries, especially emerging 2005, and the authors gratefully acknowledge market economies, the public sector has in the comments made by the Committee recent years been accumulating sizeable cross- members on that occasion. In addition, in border financial assets, mainly in the form of September 2005 the report was sent to the official foreign exchange reserves. World General Council of the European Central reserves have risen from USD 1.2 trillion in Bank (ECB) and, subsequently, to the January 1995 to above USD 4 trillion in Economic and Financial Committee, a September 2005, growing particularly rapidly consultative committee that contributes to the since 2002. The impressive pace of reserve preparation of the work of the ECOFIN growth has become an important issue on the Council. international policy agenda and has been considered from various perspectives, including the financing of the growing US current account deficits, the debate on high net savings in the Asian economies and oil- exporting countries, the sustainability of reserve accumulation, and the factors behind exceptionally low yields within and outside the United States. In January 2005 the International Relations Committee (IRC), a committee established by the European System of Central Banks (ESCB) to deal with international monetary and financial affairs, asked a group of ESCB central bank experts to study the accumulation of foreign reserves in greater detail. The ensuing report by the IRC task force investigated the features, drivers, risks and costs of reserve accumulation, as well as the other uses that certain countries have been making of their accumulated foreign assets. The report also reviewed the main trends in 1 Georges Pineau (ECB) chaired the IRC task force and central bank reserve management and provided coordinated its work. Ettore Dorrucci (ECB) drafted the paper, and the other task force members carried out the some evidence for the impact of reserve corresponding background studies as acknowledged in the accumulation on yields and asset prices. footnotes to each of the seven annexes. ECB Occasional Paper No. 43 February 2006 5 MEMBERS OF THE INTERNATIONAL RELATIONS COMMITTEE TASK FORCE ON ACCUMULATION OF FOREIGN RESERVES European Central Bank Georges Pineau Ettore Dorrucci Fabio Comelli Angelika Lagerblom Nationale Bank van België/ Banque Nationale de Belgique Michel Soudan Deutsche Bundesbank Gudrun Leichtlein Banco de España Emiliano González-Mota Banque de France Guy Levy-Rueff Banca d’Italia Maurizio Ghirga De Nederlandsche Bank Philipp Maier Banco de Portugal Teresa Balcao Reis Suomen Pankki Jouko Rautava OTHER AUTHORS OF THIS OCCASIONAL PAPER Deutsche Bundesbank Antje Kreye Banco de España Lucía Cuadro Sáez Sergio Gavilá ECB Occasional Paper No. 43 6 February 2006 SUMMARY SUMMARY strong depreciation of their currencies, the crisis-hit Asian economies pursued export-led World foreign exchange reserves grew from growth supported by exchange rate regimes USD 1.2 trillion in January 1995 to more than anchoring their currency, de jure or de facto, USD 4.0 trillion in September 20052. Reserve to the US dollar. Third, certain features of accumulation in this period exhibited four the domestic financial systems of EMEs, features that seem largely unprecedented. especially in Asia, are likely to have played Three of these features became particularly a role. Such characteristics relate mainly to: prominent in 2002-04. First, world reserves (i) their underdeveloped local financial grew by around 85% (or 91% if the first eight systems, entailing difficulties in properly months of 2005 are included), at a pace three channelling domestic private savings to times faster than
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