Managing international capital reserves

International reserves form an integral part of a country's overall portfolio of foreign assets and liabilities, and it is important that the portfolio manager should decide on an appropriate level of reserves and on when the government should borrow in order to support or increase the reserves level. In principle a higher level of reserves should be maintained when a country has variable export earnings, high debt exposure, inflexible economic policies and structures or is unlikely to have access to a steady flow of external capital. According to this theory, most developing countries should have higher reserve coverage levels than industrial countries, and this has been borne out in practice. Experience has shown that developing countries should maintain enough reserves to allow for adjustment to domestic or international pressures without unduly jeopardizing their economic growth.

It is sometimes possible to augment low reserves by borrowed funds or lines of credit; but this is a costly strategy since costs of borrowing usually exceed earnings on reserves by one or two percentage points and unused lines of credit involve commitment fees. Borrowing also increases future debt service payments and is subject to roll-over problems. Limited borrowing for reserve accumulation may nonetheless be desirable, especially as borrowing is usually easier and cheaper when funds are not needed urgently and as the level of reserves is itself an important indicator to financial markets of a country's financial soundness, thus leading to potentially lower borrowing costs. In addition, if a government borrows when funds are not urgently needed it may be able to tap new sources of finance, such as the bond market.

In developing countries the ratio of reserves to imports tends to rise and fall in line with commodity price booms. Reserve levels in low-income African countries fell to particularly low levels in the early 1980s while those in oil-exporting countries, having risen sharply in the 1970s, subsequently fell back almost as fast when foreign exchange holdings were absorbed by development programmes. Some countries, such as India (1975-80) and China, deliberately maintain high reserves, while others may allow reserves to remain at low levels for long periods of time.
Type Classification:
D: Detailed strategies
Related UN Sustainable Development Goals:
GOAL 8: Decent Work and Economic Growth