The Economy: International reserve requirements and what it means for the economy?
The graph below depicts the movements in Guyana’s international reserves during the period 2009 and up to the first quarter of 2018.
The minimum target for the international reserves held with the central bank is usually bench-marked to three months of import cover – that is, the equivalent of the country’s total import bill of goods and services from the rest of the world, for three months.
To this end, looking at Guyana’s total import figure over the last decade, total imports reached a high of US$1.97B in 2012 and a low of US$1.14B in 2009, giving rise to an average annual import figure of US$1.5B (this is derived by adding the total import figures for the last ten years and divided by ten from the Bank of Guyana Annual reports).
Therefore, using the highest import figure of US$1.97B; three months import cover is equal to: US1.97B / 12(months) x 3(months) = US$492.5M. Thus, rounded to the nearest hundred, the minimum reserve target for the central bank should be US$500M.
The data in the graph below further revealed that international reserves reached a high of just over US$800M in 2012 and a record low in the last decade of under US$500M as of the last quarter in 2018 to US$498M.
The nature and function of foreign reserves
Foreign reserves include gold and/or central bank assets which is entirely within its control and are easy to trade on international financial markets. According to the fifth edition of the International Monetary Fund’s (IMF) Balance of payments manual, “reserves assets consist of those external assets that are readily available to and controlled by monetary authorities for direct financing of payments imbalances through intervention in exchange markets to affect the currency exchange rate, and/or for other purposes” (Manchev et.al, 2009).
The primary reason for countries to hold foreign reserves has always been liquidity and insurance: to guard against the unforeseen. The IMF definition clearly states that foreign reserves are to serve foremost for: (1) financing foreign payment imbalances and; (2) maintaining a set exchange rate level.
Countries usually face constant demands for foreign payments for trade purposes, necessitating a reserve to accumulate and disburse foreign payments. Foreign trade and domestic policies also lead to the accumulation of foreign debt which is serviced with foreign exchange.
To this end, the debtor country is normally able to generate a revenue stream with which to settle its obligations. Payment difficulties can be caused by unreasonable economic policies or shock falls in foreign revenue and it is in this circumstance that the foreign reserves then become a source of liquidity.
The main functions of foreign reserves are to:
- To act as a monetary policy instrument;
- To act as an exchange rate instrument helping to cut fluctuations in the exchange rates of the national currency against foreign currencies;
- To act as a liquidity buffer in case of an international financial market crash;
- To reduce vulnerability to external factors and safeguard against crises;
- To boost stability and confidence in financial markets, since reserves are among the foremost indicators monitored by international agencies;
- To act as a source of subsidiary revenue derived from managing them.
Macroeconomic economic effects of foreign exchange reserves – evidences from the Caribbean
In a study conducted by a group of economists / analysts (Greenidge et.al) specific to Caribbean countries – it was found that the effect of foreign reserves on economic growth was shown to depend on the level of import cover and exports and consumption on the regime of interest rates.
The results of the study implied that if Caribbean Governments are to boost economic growth they must accumulate foreign reserves. Those country who are below the standard three months import reserves cover must seek to improve the level of reserves given that they are heavily dependent on imports for their goods and services.
The paper suggested that reserves can affect growth through the exports and productive investment. On the contrary, Caribbean Governments should avoid employing reserves to fuel consumption and external debt as the findings in Greenidge et.al, study indicated that reserves negatively impact these two components.
Putting this into perspective within Guyana’s context, as can be observed from looking at the trend of the movements of Guyana’s international reserves; one can observe that it is on a downward trajectory – meaning the reserves are being depleted at a seemingly rapid rate which is cause of concern.
In this regard, the Guyanese policymakers need to reverse this trend by avoid using the reserves to service external debt, and for other consumption purposes should this be the case, and seek to rebuild the international reserves to levels above the minimum three months import cover benchmark. Because, should the reserve continue to erode, such an outcome would trigger negative consequences on exchange rates and a series of other economic problems.
*The author is the holder of a Master of Science Degree from a UK university in Business Management, with specialism in Global Finance and Financial Markets.