The European Central Bank says in a report published on Wednesday, that in a number of countries, especially emerging market economies, the public sector has in recent years been accumulating sizeable crossborder financial assets, mainly in the form of official foreign exchange reserves.

Source: The accumulation of foreign reserves, by an International Relations Committee Task Force, March 2006

 

World reserves have risen from $1.2 trillion in January 1995 to above $4 trillion in September 2005, growing particularly rapidly since 2002. The impressive pace of reserve growth has become an important issue on the international policy agenda and has been considered from various perspectives, including the financing of the growing US current account deficits, the debate on high net savings in the Asian economies and oil exporting countries, the sustainability of reserve accumulation, and the factors behind exceptionally low yields within and outside the United States.

In January 2005 the International Relations Committee (IRC), a committee established by the European System of Central Banks (ESCB) to deal with international monetary and financial affairs, asked a group of ESCB central bank experts to study the accumulation of foreign reserves in greater detail. The ensuing report by the IRC task force investigated the features, drivers, risks and costs of reserve accumulation, as well as the other uses that certain countries have been making of their accumulated foreign assets.

The report also reviewed the main trends in central bank reserve management and provided some evidence for the impact of reserve accumulation on yields and asset prices.

In the report, the ECB warns that Asian countries' rapid and "unprecedented" accumulation of foreign reserves is heightening the dangers of inflation and asset bubbles.

The ECB says that while world reserves more than tripled in the past ten years, they have almost doubled in the last four years alone, with the rate of accumulation increasing dramatically since 2002.

The report says that at their height, Japanese purchases might have reduced the yields on three-year US Treasury bonds by 65 basis points -a  basis point is one-hundredth of a percentage point.

The report also says that the rapid accumulation of foreign reserves has reflected the desire of emerging economies to "self insure" against financial crises, rather than rely on institutions such as the International Monetary Fund. Another key factor has been the under-developed financial systems of such countries and the global role of the dollar and US financial institutions.

Emerging economies have also accumulated reserves as part of policies geared towards boosting exports by anchoring exchange rates to the dollar. However, the authors point out that intervening in foreign exchange markets creates inflationary dangers and can fuel asset price bubbles and that "interventions have been larger and more prolonged in recent years".

The share of world foreign reserves held by Asian economies grew from 46% in January 1995 to 64% in August 2005. In particular, the Asian monetary authorities accounted for 77% of the increase in the period 2002-05. As a result, eight Asian monetary authorities are currently among the ten largest reserve holders, with seven of them owning more than $100 billion. Sizeable foreign asset accumulation has been also taking place in oil-exporting countries such as Russia, Algeria and Norway.

In 2005, China's foreign exchange reserves rose to $770 billion, or almost 40 per cent of gross domestic product. The report says that the rise in Chinese inflation between 2002 and 2004 partly explained by the country's difficulties in "sterilising" the inflationary consequences of foreign exchange intervention. Other "risks and costs" identified, included the misallocation of investment, difficulties in managing monetary policy and "potentially sizable capital losses" at central banks if exchange rates were to change suddenly.

Download report.