Copyright
©2013 International Monetary Fund
Cataloging-in-Publication Data
Joint Bank-Fund Library
Assessing reserve adequacy in low-income countries / Valerio Crispolti… [et al]. – Washington, D.C.: International Monetary Fund, c2013.
p. ; cm. – (Occasional paper; 276)
Includes bibliographical references.
ISBN: 978-1-61635-412-1
I. Foreign exchange reserves – Developing countries. I. Crispolti, V. (Valerio).
II. Series: Occasional paper (International Monetary Fund); no. 276.
III. International Monetary Fund.
HG3853.4.A87 2013
Disclaimer: The views expressed in this book are those of the authors and should not be reported as or attributed to the International Monetary Fund, its Executive Board, or the governments of any of its member countries.
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Contents
Preface
1. Introduction
2. External Shocks and Macroeconomic Performance
Consequences for Growth and Welfare
3. Anatomy of External Shocks in Low-Income Countries
Event Study Analysis
Shock Frequency and Size
Macroeconomic Impact of External Shocks (1980–2007)
The Role of International Reserves
The Global Financial Crisis (2007–10)
4. Stylized Facts
Recent Trends
Explaining Demand for Reserves
5. Optimal Precautionary Reserves
Analytical Framework
External Shocks and Crisis Events
Benefits of Holding Reserves
Cost of Holding Reserves
6. Calibrating Reserves for Country Groups
Benchmark Calibration and Sensitivity Analysis
Results across Country Groups
7. Conclusion
Appendix 1: Data Sources and Definitions: Event Study Analysis
Shock Variables
Economic Variables
Appendix 2: Robustness Analysis
Appendix 3: Data and Robustness Analysis: Optimal Reserves
Data
Robustness Analysis
References
Index
Figures
2.1. Distribution of Country Characteristics among Low-Income Countries and the Rest of the World
2.2. Growing Integration between Low-Income Countries and the Global Economy
2.3. Macroeconomic Volatility in Low-Income Countries, 1980–2009
3.1. Definition of Shock Episodes
3.2. Identifying the Cost Associated with a Shock
3.3. Macroeconomic Impact of Terms-of-Trade Shocks
3.4. Macroeconomic Impact of Shocks by Structural Characteristics
3.5. Costs by Shock Type
3.6. Costs by Shock Type and Structural Characteristics
3.7. Annual Losses and Level of Reserves
3.8. Costs of External Shocks by Variable and Type of Shock
3.9. Absorption Costs of External Shocks by Reserve Coverage
3.10. Costs of External Shocks by Structural Characteristics of the Economy
3.11. Macroeconomic Impact of the Crisis
3.12. Macroeconomic Impact of the Crisis by Level of Reserves
3.13. Macroeconomic Performance by Level of Reserves and Structural Characteristics
4.1. Recent Trends in Reserve Accumulation in Low-Income Countries and Emerging Markets
4.2. Median Reserve Coverage in Low-Income Countries
4.3. Low-Income Countries: Actual and Predicted Reserves, 2003–2008
4.4. Actual and Predicted Reserves to GDP, by region
5.1. External Shock Episodes
5.2. Marginal Effects on the Probability of a Crisis
6.1. Sensitivity of Optimal Reserves to Country Fundamentals
6.2. Actual versus Computed Reserves, 2008–2009
A2.1. Costs of External Shocks by Variable and Type of Shock (25th percentile)
A2.2. Costs of External Shocks by Variable and Type of Shock (Whole-Sample Distribution)
A2.3. Macroeconomic Performance by Level of Reserves and Structural Characteristics
A2.4. GDP and Consumption Costs by Type of Shock
A2.5. GDP Costs by Type of Shock and Level of Reserves
A2.6. Consumption Costs by Type of Shock and Level of Reserves
Tables
2.1. Frequency of Shocks Across Country Groups (1970–2007)
3.1. Frequency and Size of Shocks
3.2. Frequency and Size of Shocks by Region
4.1. Estimating Reserve Demand in LICs
5.1. Median Growth Rate of Absorption and Consumption
5.2. Probability of Absorption Drops
5.3. Fundamentals and Marginal Effects on Crisis Probability
5.4. Absorption Loss Regression
6.1. Calibrated Optimal Reserves for LICs
A1.1. List of Countries and Structural Characteristics of the Economy
A2.1. Frequency and Size of Shocks (25th percentile)
A2.2. Frequency and Size of Shocks (Whole-Sample Distribution)
A2.3. Macroeconomic Variables (1980–2007): Summary Statistics
A2.4. Macroeconomic Impact of Shocks
A2.5. SDR Allocations
A2.6. Macroeconomic Impact of the Crisis
A3.1. Absorption Drop Probit Regression: Robustness Check
A3.2. Probability of Consumption Drops
A3.3. Absorption Loss Regression: Robustness Check
A3.4. Consumption Loss Regression
A3.5. Sensitivity Analysis of Calibrated Optimal Reserves
Preface
Low-income countries (LICs) are routinely faced with exogenous disturbances—sharp swings in the terms of trade and export demand, natural disasters, and volatile financial flows—that contribute to higher volatility in aggregate output and consumption as compared to other countries. Although sound macroeconomic policy frameworks are the first line of defense for limiting country vulnerability, international reserves constitute the main form of self-insurance against such shocks. But assessing reserve adequacy in LICs has been bedeviled by the lack of an agreed methodological framework, with policymakers relying on rules of thumb, such as maintaining reserves equivalent to three months of imports, to evaluate a country’s need. Although such metrics are intuitive and simple, they do not have fully developed theoretical and empirical foundations. Building on an event study analysis of a range of external shocks faced by LICs, this Occasional Paper presents a tractable analytical framework that helps quantify the level of reserves that can be rationalized in terms of insurance against the types of large external shocks faced by LICs.
The paper was prepared as input into the IMF Policy Paper, “Assessing Reserve Adequacy” (2011), by a staff team led by Era Dabla-Norris, Deputy Chief of the Low-Income Strategy Unit in the Strategy, Policy, and Review Department. The other authors were Valerio Crispolti, Jun Il Kim, Kazuko Shirono, and George Tsibouris. Charles Amo-Yartey contributed to Chapter 4. The authors are grateful to Hugh Bredenkamp, Deputy Director, Strategy, Policy, and Review Department, for his guidance and support and helpful suggestions throughout the project, and to Sibarata Das and Ke Wang for excellent research assistance.