Countries that held more international reserves relative to their short-term debt were less negatively affected by the global financial crisis and had stronger economic growth. These are among the findings of research by Noëmie Lisack and colleagues, to be presented at the Royal Economic Society''s 2014 annual conference.
Their study analyses more than 100 emerging market and developing countries to compare increases in GDP to the countries'' ratios of international reserves to short-term debt. According to the report:
· The international reserves to short-term debt ratio is the most useful indicator to explain real output growth during the crisis.
· Increasing the reserves to short-term debt ratio increases economic growth. If the reserves to short-term debt ratio is doubled, growth is 0.4 to 0.5 percentage points higher than it would otherwise be.
· The lower the degree of capital openness, the greater the impact of the reserves/short-term debt ratio.
· The positive impact of reserves could arise from reserve depletion mitigating economic distress by defending a currency or merely by deterring speculation against a currency. Deterrence seems to be the primary channel.
· There has been a significant post-crisis reserves rebuilding. The lower the pre-crisis reserve adequacy ratio, the more pronounced the rebuilding. And the larger the depletion of reserves during the crisis, the stronger the rebound in reserve accumulation.
In the decade preceding the 2008 global financial crisis, emerging market economies accumulated large stocks of international reserves. The unprecedented pace of reserve accumulation was, at least partly, a response to the lessons drawn from previous emerging market financial crises. Research suggests that countries with an insufficient level of reserves suffered more from crises in the 1990s.
To what extent has the accumulation of international reserves protected countries from the negative shock of the latest crisis? Have countries with more reserves fared better than countries with fewer reserves? Are there other policy tools that can strengthen or dampen the effects of reserves on growth?
Growth and international reserves during the crisis
This study examines these questions using sample of 112 emerging market and developing countries. The benchmark specification relates GDP growth measures to the reserve to short-term debt ratio, lagged two periods to account for possible two-way feedback effects.
The researchers use two measures of growth. Their first growth measure is the difference between the realised real economic growth rate and a prediction from a historical mean. The alternative dependent variable captures the change between the actual real GDP growth in 2009 and the IMF World Economic Outlook forecast in the first quarter of 2008, before the Lehman collapse.
The study also tests for several measures of reserve adequacy, but finds that the reserves to short-term debt ratio is the most useful indicator to explain real output growth during the crisis. The stock of foreign reserves scaled by the level of short-term debt is positively and significantly correlated with the real GDP growth deviation from the trend.
Growth is about 0.4 to 0.5 percentage points higher than would otherwise occur if the reserves to short-term debt ratio were to double. This estimate is from a specification that omits any interactive effect from capital openness.
The researchers find that the lower the degree of capital openness, the greater the marginal impact of reserves/short-term debt. Dropping outliers tends to increase the importance of reserves/short-term debt.
Why do reserves matter? It could be that the reserve depletion itself (for defending a currency) mitigates economic distress; or perhaps the mere existence of large reserves deters speculation against a currency.
To investigate, the researchers augment their regressions with a dummy variable to account for reserve depletion and find that the importance of the reserves/short-term debt ratio retains its statistical significance, while the coefficient on reserve depletion is not statistically significant, suggesting the deterrence channel is of primary importance.
After the crisis
Two salient points: First, there has been a significant post-crisis reserves rebuilding. The lower the pre-crisis reserve adequacy ratio, the more pronounced the rebuilding.
Second, the larger the depletion of reserves during the crisis, the stronger rebound in reserve accumulation. This seems to confirm countries'' increasing appetite for reserve assets as a self-insurance.
The results presented in this study suggest that the global financial crisis has further demonstrated the usefulness of reserves: empirically, the countries that held more reserves as a ratio to short-term debt have been less negatively affected than others, ceteris paribus. They also suggest that this effect is especially strong when the capital account is less open.
Given the demonstrated usefulness of reserves, it is not surprising that stocks have been rebuilt quickly in the aftermath of the crisis. Nonetheless, in the most recent period, the pace of reserve accumulation has slackened, in line with the deceleration in the pace of short-term debt accumulation, suggesting that should short-term debt levels plateau, so too should reserves.
''For a Few Dollars More: Reserves and Growth in Times of Crises'' by Matthieu Bussière, Gong Cheng, Menzie Chinn and Noëmie Lisack