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).
As an aside, the yen has failed to materially weaken, despite the Japanese Finance Ministry’s recent verbal intervention. This highlights how a widening policy-credibility deficit can stymie policy-makers’ ability to slow, let alone stop, rapid FX appreciation. If, and it’s a big if, the Finance Ministry intervenes in the FX market before the BoJ’s 28th April policy meeting, it will have to be aggressive to be effective.
EM central banks have only used a fraction of the war-chest accumulated
The USD-value of EM central bank FX reserves fell about $1.1trn to around $7.61trn in February from their peak in mid-2014 – an average monthly fall of about $57bn. But FX reserves were still $2.3trn higher than before the 2008 great financial crisis (see Figure 1).
Put differently, EM central banks have so far only used up a third of the FX reserves they built up between September 2008 and mid-2014.
FX valuation effects account for about $500bn of the fall in $-value of FX reserves
Currency valuation effects – the US dollar’s appreciation against other reserve currencies – account for nearly half of the fall in the USD-value of FX reserves since mid-2014 according to my estimates (see Figure 3). Based on IMF COFER data, the dollar’s appreciation versus the euro, yen, sterling, Canadian dollar and Australian dollar has cut the USD-value of FX reserves by about $515bn (please see Methodology section for further details).
Adjusting for these valuation effects, EM FX reserves fell only $626bn between June 2014 and February 2016 (see Figures 1 and 3). This equates to an average monthly fall of only $31bn or 0.35%.
Outside of China and commodity exporters, FX reserve picture generally decent
The fall in China’s central bank FX reserves accounts for the bulk of the fall in total EM FX reserves. Specifically, China’s reserves fell $790bn between June 2014 and February 2016 (see Figure 4), which accounts for 70% of the fall in EM reserves (see Figure 5).
Excluding China and adjusting for valuation effects, EM FX reserves fell only $52bn or 1% between June 2014 and February 2016 (see Figures 2, 5 and 6). Regionally, reserves:
- Decreased $216bn (13%) in Emerging Europe, Middle East and Africa;
- Increased $11bn (1.5%) in Latin America; and
- Increased $154bn (7%) in Non-Japan Asia
The overall fall in FX reserves has perhaps unsurprisingly been concentrated in commodity exporting economies, namely Malaysia, Nigeria, Russia and Saudi Arabia, and in China (see Figure 7).
FX reserves up in March, even accounting for weaker USD
FX reserves in EM countries which have so far released March 2016 data rose about 0.8% in March to $6.15trn or about 0.6% accounting for modest currency valuation effects (a weaker dollar). Excluding China, reserves were up about 1.4% or 1.1% adjusting for valuation effects (see Figure 8). This likely reflects in part stronger net capital inflows into EM economies in March as global risk appetite rebounded on a weaker dollar and higher oil prices.
Moreover, the increase in March was broad-based. While the $-value of FX reserves continued to fall in Armenia, Hungary and Ukraine, it rose all NJA economies as well as Belarus, Bulgaria, Chile, Colombia, El Salvador, Georgia, Kazakhstan, Poland, Romania, Russia, South Africa and Thailand.
FX reserves modest in Africa, still sizeable in most of Asia and Saudi Arabia
There are many measures of the relative size of a central bank’s FX reserves. The simplest is probably reserves expressed as a percentage of GDP, one of the more common is as months of imports of goods (see Figures 9 & 10). Both have their advantages and disadvantages.
- Reserves are small in the main African economies (Egypt, Nigeria and South Africa), Poland, Romania, Turkey, Argentina, Chile, Mexico and Indonesia.
- They remain modest in India despite the increase since mid-2014.
- Chinese and Russian FX reserves are average as a percentage of GDP but large when expressed in months of imports.
- Saudi Arabia’s FX reserves have fallen 20 percentage points of GDP since June 2014 (see Figure 9) but remain sizeable both as a percentage of GDP and as months of imports (see Figure 10).
- Taiwan’s FX reserves have risen slightly and are sizeable on both metrics.
Size is not the be all and end all
Whether and in what size central banks are willing to use FX reserves to shore up their currencies should they come under pressure in coming months – my core scenario – is a more complex issue (see Emerging Market currencies – don’t call this a comeback, 6 April 2016).
History suggests that NJA central banks are likely use FX reserves to fade acute/prolonged currency depreciation.
The 27% fall in the USD-value of Malaysia’s central bank FX reserves since mid-2014, equivalent to about 10.7 percentage points of GDP, suggests that Bank Negara Malaysia may have sold FX reserves to support a ringgit under pressure from falling commodity prices.
China’s central bank (SAFE) has seemingly been willing to counter large capital outflows and ease the pressure on the renminbi by running down its FX reserves – against the engrained consensus that SAFE would allow rapid CNY depreciation or even devalue the currency in order to support exports and growth (see Figure 11).
But precedent also suggests that NJA central banks are likely to accept a degree of currency depreciation and would fade sustained currency appreciation, as exports and inflation remain tepid while Indonesia’s central bank FX reserves are modest.
This willingness and ability of NJA central banks to intervene in the FX market (buying/selling hard currency) and fade more extreme currency moves has contributed to the pace of currency change remaining within reasonably narrow bands in recent years (see Figure 12). Currently a GDP-weighted basket of NJA nominal effective exchange rates (NEERs) is broadly unchanged versus a month ago.
The aberration of Abenomics
As an aside, the yen has failed to materially weaken, despite the Japanese Finance Ministry’s recent verbal intervention, in turn weighing on the Nikkei (see Figure 13). This highlights how a widening policy-credibility deficit can stymie policy-makers’ ability to slow, let alone stop, rapid FX appreciation.
There are a number of tactical reasons why the Finance Ministry may not yet go a step further and intervene in the FX market to weaken the yen. For starters Japan is hosting the next G7 summit on 26-27th May and may want to avoid any suggestion of manipulating its currency.
From a more fundamental perspective, it’s not obvious that a stronger yen is yet really hurting Japanese exports. They have held up reasonably well, even when measured in yen (see Figure 14), and the trade balance has moved back into surplus for the first time in five years (see Figure 15).
An important caveat is that the loss of yen competitiveness since December could start to weigh on the economy and trade in coming months given the typical lags in contractual pricing (the latest available Japanese data is for February). This would arguably give the Finance Ministry a more tangible reason to intervene.
In any case, if, and it’s a still big if, the Finance Ministry intervenes in the FX market before the Bank of Japan’s 28th April policy meeting, it will have to be aggressive to be effective.
Methodology behind EM central bank FX reserves data and calculations
1. Country coverage
The countries included are Albania, Argentina, Armenia, Belarus, Brazil, Bulgaria, Chile, China, Colombia, Croatia, Egypt, El Salvador, Georgia, Hong Kong, Hungary, India, Indonesia, Jordan, Kazakhstan, the Kyrgyz Republic, Korea, Lithuania, Malaysia, Mexico, Moldova, Morocco, Nigeria, Peru, Philippines, Poland, Romania, Russia, Saudi Arabia, Singapore, South Africa, Taiwan, Thailand, Tunisia, Turkey, Ukraine and Uruguay. Their aggregate GDP in 2014 was about $28.3trn or 36% of world GDP.
A few small EM economies for which monthly data are not readily available are omitted. This does not change the underlying trends or my conclusions.
The data are for central banks’ foreign assets, as defined by the IMF. They include foreign currency reserves, IMF reserve position, SDRs, gold and other reserve assets. For China, a long-time series of SAFE’s foreign assets is not available and I therefore use foreign currency reserves (which account for nearly 98% of China’s foreign assets).
3. FX-valuation effects
Most central banks do not publicly report the currency composition of their FX reserves, instead reporting their composition to the IMF which then aggregates the data. Therefore FX-valuation effects for a specific country or group of countries can only be estimated. I use the IMF Currency Composition of Official Currency Reserves (COFER) data for allocated reserves to estimate the size of any FX-valuation effects (see Figure 16). Note that the IMF will separately identify the renminbi in its official foreign exchange reserves database starting 1 October 2016.
Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He has over 15 years’ experience with two of the world’s largest investment banks as an emerging markets economist, rates and currency strategist.
 Includes Albania, Armenia, Belarus, Bulgaria, Croatia, Egypt, Georgia, Hungary, Jordan, Kazakhstan, the Kyrgyz Republic, Lithuania, Moldova, Morocco, Nigeria, Poland, Romania, Russia, Saudi Arabia, South Africa, Tunisia, Turkey and Ukraine
 Includes Argentina, Brazil, Chile, Colombia, El Salvador, Mexico, Peru and Uruguay
 Includes Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Thailand and Taiwan
 The fall in Singapore’s FX reserves is most likely smaller than depicted due to particularly large FX-valuation effects. The (strong) dollar reportedly accounts for a smaller share of Singapore’s FX reserves than the average 60% reported in the IMF’s COFER. Adjusting for the relatively heavy weight of the euro, sterling and yen in Singapore’s reserves, the change in the $-value of reserves since June 2014 has been negligible.
 I include Hong Kong, Korea, Singapore and Taiwan for the purpose of this analysis even if these countries are arguably developed rather than emerging – see Emerging Markets falling between the cracks (and BRICS), 5 March 2015.