IMF Discusses Reserves Accumulation and International Monetary StabilityPublic Information Notice (PIN) No. 10/72
June 4, 2010
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On May 28, 2010, the Executive Board of the International Monetary Fund (IMF) held a seminar on Reserves Accumulation and International Monetary Stability. The paper reviews links between official reserves accumulation and international monetary stability and considers initial ideas and options to make the international monetary system (IMS) more robust to recurrent crises. The purpose at this stage is to consider the efficacy of various options and identify general directions for further reflection rather than to converge on specific policy proposals. The discussion takes place amidst a long-running debate on the stability of the IMS, and in the context of the broader program of work on the IMF’s mandate (http://www.imf.org/external/np/exr/consult/2010/SPR/), complementing discussions on the Fund’s future financing role (The Fund’s Mandate—Future Financing Role, PIN No. 10/51) and surveillance (Modernizing the Surveillance Mandate and Modalities and Financial Sector Surveillance and the Mandate of the Fund, PIN No. 10/52).
Reserve accumulation has accelerated in the past decade, and looks set to resume as the global recovery takes hold. Total reserves have reached levels well above traditional benchmarks, particularly in emerging markets (about 10 months of imports or 475 percent of short-term external debt in 2008). Rapid reserve accumulation is related to market failures and potential vulnerabilities in the broader monetary and financial system, such as surges and sudden stops in capital flows; the absence of automatic adjustment to imbalances; and asymmetric adjustment to shocks, with countries choosing to gear policies towards achieving external surpluses and reserve-issuing countries facing limited pressure to change course relative to others. While it has its benefits, accumulating reserves is costly—consumption and investment are foregone as a part of national savings are invested in safe, low-yielding international assets. At the same time, large reserve accumulation focused on a narrow supply can pose systemic costs as funds are directed to a small set of assets, potentially stoking asset bubbles, and as systemic stability relies importantly on the economies and policies of a small number of issuing countries. The paper explores these issues and sets out ideas to enhance the stability of the IMS by alleviating the demand for reserves and broadening the supply of reserve assets.
Executive Board Assessment
Executive Directors welcomed the opportunity to reflect on initial ideas and options to enhance the stability and resilience of the IMS. While this is a long-term issue, it merits attention in the context of the ongoing review of the Fund’s mandate. Today’s seminar advances the ongoing assessment of IMS stability, and complements recent deliberations of the Fund’s future financing role and surveillance.
Motivation. Most Directors observed that the current IMS has demonstrated its resilience, although increasing pressures are evident. The unprecedented buildup of international reserves in recent years, with its concentration in a narrow set of currencies—though partly reflecting policy choices—points to systemic imperfections, such as the absence of automatic adjustment to imbalances, asymmetric adjustment to shocks, and uneven availability of international liquidity. While reserves have served countries well during periods of crisis, it will nevertheless be worthwhile to explore pragmatic options to reduce the growth in demand for reserves, together with those for a more diversified supply of reserve assets. A few Directors emphasized that reserve accumulation is just a symptom, not the cause, of potential instability. Some Directors, however, did not see serious shortcomings in the current system that need to be addressed. First and foremost, sound macroeconomic and financial policies, particularly by reserve issuers and other systemic countries, remain central to the long-term stability of the system. Enhanced Fund surveillance over members’ policies is, therefore, critical to IMS stability.
Mitigating reserve demand. Directors considered a number of options to mitigate the growth in demand for reserves:
• Reserve adequacy. Many Directors supported further analytical work to provide guidance on appropriate levels of precautionary reserves tailored to country circumstances, including the costs and benefits of holding reserves, and ways to address ratchet effects. Some were skeptical about the applicability of such work.
• Reducing underlying volatility. Directors called for improved analyses of volatile capital flows—a key motivation for self-insurance. Many viewed addressing information gaps on gross cross-border flows and exposures as a welcome step. While a number of Directors also saw merit in considering a multilateral framework for managing capital flows, with the Fund’s role in providing policy advice that would help minimize distortions, a number of others were not in favor of such an approach. Directors supported further work on the potential Fund role in helping its members reap the benefits from capital flows while sustaining domestic and global stability, including by developing domestic capital markets.
• Reducing non-precautionary accumulation. Noting the difficulty in discerning the motivations behind reserve accumulation, and given the cooperative nature of the Fund, most Directors viewed a regime of penalties to alleviate persistent imbalances as unfeasible, although a few called for further consideration. More voluntary options could be explored—for example, along the lines of the G-20 Mutual Assessment Process. In this context, several Directors looked forward to the forthcoming paper on assessing reserve adequacy.
Expanding reserve supply. The following ideas to diversify the supply of reserve assets were explored, with a view to enhancing the stability of the IMS over the long run:
• Multi-polar system. Many Directors considered that a shift toward a more multi-polar system will likely evolve gradually over time. Some Directors noted that the current system already consists of multiple reserve currencies, and that the role of emerging market assets in the IMS will likely grow. To facilitate an orderly transition, some Directors saw a role for the Fund in promoting the transparency of members’ reserve holdings, in particular currency composition; however, a few argued against disclosing such market-sensitive information.
• SDR. Many Directors supported, or were open to, exploring in greater detail options to enhance the role of the SDR, including possibly scaling up its supply, revisiting allocation rules, and encouraging broader use of SDR-denominated instruments. Others regarded these ideas as neither realistic nor practical. The potential costs and implications of SDR-related proposals would need to be examined carefully if any of them were to be considered further.
• Sui generis global currency. Directors broadly considered that a global currency option is highly unrealistic at this stage, requiring considerably more debate on its merits and feasibility.
Next steps. Directors expressed a wide range of views today, including offering some new ideas, which would need to be reflected on in staff’s future work. Directors will have further opportunities to discuss pragmatic steps that the Fund and members could jointly take to strengthen the stability of the IMS, including in the areas of capital flows, reserve adequacy, and the role of the SDR.