Press Release No. 15/176

Press Release: IMF Executive Board Discusses Reserve Adequacy Assessment

April 24, 2015

On January 21, 2015, the Executive Board of the International Monetary Fund (IMF) discussed a staff paper on Assessing Reserve Adequacy.

In conjunction with sound policies and fundamentals, reserves can help reduce the likelihood of balance of payment crises and preserve economic and financial stability. However, while they bring important benefits, reserve holdings can also be costly.

To facilitate a broader assessment of reserve adequacy in IMF surveillance, the staff paper discussed by the Board brings together recent IMF work on these issues contained in Assessing Reserve Adequacy and Assessing Reserve Adequacy--Further Considerations. In terms of reserve holdings for precautionary purposes, the paper argues that considerations underpinning a country’s reserve needs depend on the risks and vulnerabilities it faces as well as its economic and financial structure, and, to this end, it outlines methodologies to help inform the discussion on reserve adequacy in staff reports. The paper also recognizes that reserves can reflect important non-precautionary motives for some countries.

Executive Board Assessment

Executive Directors welcomed the opportunity to return to the discussion on the scope and coverage of reserve adequacy issues in bilateral surveillance. They agreed that reserves, in conjunction with sound policies and fundamentals, can bring significant benefits in reducing the likelihood of balance-of-payments crises and preserving economic and financial stability. At the same time, notwithstanding the benefits of prudent reserve levels, the accumulation of reserve positions beyond that level involves additional costs for the countries that hold them, and some Directors stressed that it can have global external costs. A few Directors, however, pointed out that such accumulation can be a symptom of the shortcomings of the international monetary system.

Reflecting the importance of reserve issues for external and global stability, most Directors supported a systematic discussion of reserve adequacy issues in Fund surveillance reports, which could help enrich staff’s analysis and policy advice, although some felt that this would be premature or unwarranted. As reserves can reflect different motives and institutional settings, Directors agreed that the depth and emphasis of the discussion should depend on country circumstances and reflect the aspects that are relevant for a country’s external stability as well as global stability. In this regard, the discussion should reflect the adequacy of reserves for precautionary purposes, the authorities’ stated precautionary and non-precautionary objectives for holding reserves, and the cost of reserves. The view of the authorities on relevant country-specific aspects would be important. In assessing reserve adequacy, some Directors noted the importance of considering the availability of alternative safety nets. However, some other Directors cautioned that alternative external buffers should not be considered as a full substitute for reserves, as these are not unconditionally available. Directors underscored the importance of judgment in making assessments and the need to avoid a mechanical application of any metric.

Considering that a country’s economic and financial structure has an important bearing on the role played by reserves, Directors generally welcomed staff’s work on country groupings for assessing reserve adequacy. Many Directors supported, or were open to, the proposed classification based on market access and economic and financial flexibility. A number of Directors, however, saw limited benefits in view of the overlap between the proposed classification and the standard classification based on per capita income, also cautioning against a new classification based on complex methodologies. A few of these Directors questioned reliance on an exercise that is largely based on subjective surveys of external agencies.

Directors agreed that a discussion on reserve adequacy can be appropriate for mature economies, as these economies are not immune to foreign exchange and external funding pressures. Given that these countries’ reserve needs are often related to acute financial market stress, an appropriate prudential and regulatory framework is crucially important to mitigate potential financial pressures. Regarding the appropriate size of reserves for precautionary purposes, Directors noted the difficulty in constructing a general metric for these economies. They broadly agreed that scenario analysis offers a helpful tool to approximate a country’s reserve needs, and supported the proposal to discuss the authorities’ reserve adequacy framework and, in that context, possible risks and reserve needs. A few Directors thought that scenario analysis could be more generally applied across countries. A few other Directors, however, noted that a common metric for mature economies would have been appropriate. A few Directors held the view that it would be premature to include reserve assessments in bilateral and multilateral surveillance for currency unions and advanced economies until further research yields more insights.

In considering reserve adequacy needs for countries with deepening financial markets and credit-constrained economies, Directors supported the use of all relevant reserve metrics, including those developed by the Fund. While no metric can provide definitive guidance for all countries, metrics can provide a useful starting point for assessing reserve needs, which could be supplemented by country-specific analysis, where warranted, to better reflect individual country characteristics.

Most Directors agreed with the methodology to calculate the Assessing Reserve Adequacy–Emerging Market (ARA-EM) metric. Some Directors, however, expressed concerns about individual components of the metric and the weights applied to them. In discussing special country cases, Directors agreed that higher external buffers could be appropriate for commodity-intensive economies given their more volatile terms of trade and more difficult adjustment to external shocks. They noted that these buffers could be met through means other than reserves, including hedging. A few Directors felt that the proposed calculation of the buffer could underestimate needed reserves. Directors also noted that the ARA-EM metric provides a useful starting point for considering the reserve needs in dollarized economies, although the metric could be supplemented with additional analysis reflecting the nature of dollarization. Finally, most Directors supported a lower weight to be applied to the risk of resident flight in countries with long-standing and effective capital flow management measures. The adjusted and unadjusted metric should be carefully explained in staff reports to support a richer discussion. A few Directors, however, felt that this adjustment of the metric for capital flow management measures is not justified, including because of measurement problems with existing measures of capital controls.

Directors took note of the proposed methods for measuring the cost of reserves. Some Directors emphasized the need to assess the outward spillovers of excessive reserve accumulation in bilateral and multilateral surveillance, consistent with the Integrated Surveillance Decision. Some Directors felt that discussion of the benefits of reserve accumulation would provide a balanced assessment. Some stressed the need for caution in assessing the costs and benefits of reserve accumulation.

To make the agreed framework operational, most Directors supported the preparation of a staff guidance note, in line with management’s planned response to the findings of the IEO’s 2012 evaluation International Reserves—IMF Concerns and Country Perspectives. A number of Directors suggested that it would be useful to present the guidance note to the Board. Some Directors cautioned against haste in implementing the proposals, noting their concerns. Directors recognized the need to continue to refine the framework over time. A few Directors noted the need for additional work to assess the drivers of non-precautionary reserve accumulation. Some pointed to the importance of broader reforms to enhance the stability of the international monetary system.