## _121914 - EXECUTIVE SUMMARY

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### Role and trade‑offs of reserves
- Reserves provide insurance against shocks and, in conjunction with sound policies, can help reduce the likelihood of balance of payment crises and preserve economic and financial stability.
- Benefits listed:
  - engender confidence in the national currency,
  - counter disorderly market conditions,
  - support the conduct of monetary policy,
  - build assets for intergenerational purposes,
  - influence the exchange rate,
  - provide space to respond to shocks and prevent disorderly market conditions.
- Costs and risks listed:
  - reserves generally yield lower returns than alternative uses;
  - sizable and persistent one-sided intervention can move an exchange rate far from its equilibrium, aggravating external imbalances and creating potential spillovers.

### Purpose and scope of the paper
- Aim:
  - bring together recent Fund work on reserve adequacy issues to strengthen discussion in bilateral surveillance and respond to the 2012 IEO evaluation recommendation that reserve assessments in bilateral surveillance reports should be more detailed and reflect country circumstances.
- Proposal for Article IV reports where warranted:
  - include a fuller discussion of the authorities’ stated objectives (precautionary and non-precautionary) for holding reserves;
  - include an assessment of the reserve needs for precautionary purposes;
  - include a discussion of the cost of reserves.
- Emphasis on evenhandedness: countries with similar circumstances to be assessed in similar ways; depth and emphasis vary by country conditions and needs.
- Scope limitation: focus on reserve adequacy issues (precautionary purposes) and not on broader Fund work topics.

### Classification of economies and methodology
- Suggested classification for reserve adequacy purposes:
  - mature markets (MMA),
  - deepening financial markets (DFM),
  - constrained market access (CMA).
- These groups largely correspond to commonly used per capita income classification.
- Methodology highlights:
  - no single indicator or model captures reserve adequacy; use all relevant indicators as a starting point and tailor with country-specific analysis.
  - Market access split: Market access (MA) vs Constrained market access (CMA).
  - MA further divided into MMA and DFM using two dimensions from ARA (2013): external financial flexibility and economic flexibility (specific indices cited).
- Cluster results and robustness:
  - Seven countries near dividing line: Chile, Malaysia, Czech Republic, Israel (above the line), Poland, Peru, Korea (below the line).
  - Aggregated maturity measure correlates with (the log of) per capita income with correlation above 0.6.
  - Clustering robustness: alternative aggregations and algorithms (K-means, K-median, Ward’s linkage correlations 0.99) with low misclassification error (< 2 percent).

### Reserve adequacy in Fund surveillance
- Surveillance Guidance Note: discussion of a country’s reserves holdings is a key element of the external stability assessment; Article IV staff reports would generally report a country’s reserves position and include an assessment of whether it is adequate in view of its specific characteristics and vulnerabilities.
- Depth of assessment depends on criticality:
  - deeper discussion where reserve adequacy issues are important for a member’s balance of payments stability and/or global stability.
- Emphasis adjustments:
  - Greater emphasis on precautionary reserve adequacy where reserves are relatively low.
  - Greater emphasis on non-precautionary motives and cost of reserves where reserves are relatively large.

### Precautionary motives and metrics
- Empirical and survey evidence:
  - about three-quarters of respondent country authorities viewed precautionary liquidity needs as the critical reason to hold reserves.
  - reserves reduce the likelihood of balance of payments pressure in EMs.
  - Advanced market economies used reserves during the global financial crisis to limit market pressures and dysfunction.
- Commonly used simple metrics (practical starting points; appropriateness varies by country):
  - import cover (months of prospective imports; "three months’ coverage" benchmark for less open capital account countries),
  - reserves to short-term debt (Greenspan-Guidotti: 100 percent cover of Short-term Debt),
  - reserves to broad money (M2) (upper end of prudent range typically 20 percent),
  - combination metrics (expanded Greenspan-Guidotti; Wijnholds and Kapteyn (2001)),
  - ARA (EM) composite metric (detailed below).

### Forward‑looking assessments and complementary buffers
- Reserve adequacy assessments should be forward looking and consider medium-term evolution because reserve positions can take time to adjust.
- Analyses can draw on expected evolution of components driving reserve need (e.g., exports, external liabilities) and anticipated drains (e.g., maturing forward/swap contracts).
- External buffers beyond reserves (e.g., central bank swap lines and contingent IFI facilities) have reserve-like features and should be considered, while recognizing differences in availability and permanence.
- Annex V provides dynamic analysis examples for South Africa and Mexico.

### Non‑precautionary motives for reserve accumulation
- Non-precautionary objectives include intangible benefits and be important factors:
  - Foreign exchange intervention under a fixed exchange regime or to achieve an inflation target if other transmission channels are ineffective.
  - Foreign assets held as part of a country’s savings to ensure intergenerational equity (e.g., in resource-endowed economies).
  - Reserve accumulation as a by-product of export-led growth strategies relying on sterilized intervention.
- Where non-precautionary motives are important, Article IV reports should reflect the authorities’ primary non-precautionary reasons following staff discussion with authorities.

### The cost of reserves — conceptual approaches and proxies
- Any assessment should consider both benefits (proxied by adequacy) and costs of reserves.
- Three conceptual approaches to determine the cost of holding reserves:
  - external funding cost for economies beginning to access capital markets, net of estimated return on foreign assets held as reserves;
  - sterilization cost incurred by the central bank when purchasing foreign exchange, netted against return on foreign reserve assets (adjust for exchange rate risk);
  - opportunity cost to the economy of devoting investible resources to liquid foreign assets, using marginal productivity of capital (MPK) as proxy (or marginal productivity of public investment for some RRs).
- Suggested proxies for the cost of holding reserves:
  - yield on sovereign borrowing for countries with limited market access,
  - return on most liquid longer-term government bonds adjusted for exchange rate risk for countries with liquid government securities markets,
  - marginal product of capital (MPK) where financial markets are thin or underdeveloped.
- Marginal cost empirical note:
  - marginal cost of holding reserves ranges from around 4 to 6 percent using alternative cost proxies.
- Operational guidance:
  - sterilization and yield-based opportunity costs are useful; choice should reflect country circumstances (e.g., adequacy, alternative uses, exchange rate stance).
  - cost of acquiring reserves most appropriate for countries with low reserve holdings;
  - net financial (opportunity) cost relevant for market access economies with adequate reserves.

### Adequacy considerations by economy type — Mature Markets (non‑reserve issuers)
- Mature markets experienced FX and funding market stress during the global financial crisis (2008): FX swap rates and U.S. dollar–libor spreads rose sharply as markets froze.
- FX market dysfunction often coincides with banking stress and can extend funding needs beyond banks to non-bank corporates.
- In extreme dysfunction periods, mature economies have used reserves to protect financial stability; several mature economies increased reserves after 2008.
- Distinction:
  - Reserve currency issuers (and those with predictable access to reserve currencies) unlikely to need sizable precautionary reserves because assets can be swapped into other currencies.
  - Non-reserve issuers without predictable access need external buffers, including reserves, as insurance against market dysfunction.

### Scenario analysis for mature (non‑reserve) advanced economies
- Scenario analysis is the preferred tool where detailed bank and market data are limited and for modeling market dysfunction.
- Scenarios typically center on:
  - risks of market dysfunction (duration; extent of liquidity drying up),
  - risks to bank and nonbank balance sheets from FX funding shortfalls.
- Proposed application:
  - approximate FX funding needs relative to existing bank and nonbank buffers using historical trading liquidity, market participant behavior, short-term funding needs, and adverse-shock assumptions.
  - Article IV consultations should discuss authorities’ reserve adequacy framework, dominant risks, possible reserve needs to stabilize markets, and costs of holding reserves.
- Explicit proposal quote:
  - "Mature market economies without a reserve currency or automatic access to reserve currencies through standing swap lines have a need for reserve buffers."

### Metrics and models for Deepening Financial Markets (DFM) / Emerging Markets
- ARA (EM) composite metric design:
  - four drains on the balance of payments: (i) export income (TX); (ii) broad money (BM); (iii) short-term debt (SDM); (iv) other liabilities (portfolio equities, medium & long-term debt).
  - Relative risk weights based on the 10th percentile of observed outflows during exchange market pressure episodes; ARA (2013) raised weight on "other liabilities" by 5 percentage points relative to earlier versions.
  - Adequacy benchmark: reserves in the range of 100-150 percent of the composite (EM) metric considered broadly adequate for precautionary purposes.
- Optimal reserve model (Jeanne and Rancière (2006)):
  - baseline calibration suggests many EMs would optimally hold reserves around 80-100 percent of short-term debt plus the current account deficit and between 75 to 150 percent of the ARA EM metric.
  - sensitivity parameters include risk aversion from 2 to 4, probability of a sudden stop from 10% to 15%, output loss from 6.5% to 10% (or country-specific).
  - with zero liquidity premium and no output loss, model reduces to Greenspan-Guidotti rule.
- Proposed application:
  - IMF ARA metric recommended for most market-access economies because of broad coverage.
  - Country-specific econometric or scenario analysis can supplement metrics (e.g., swap/forward transactions, encumbered reserves).
  - Consider additional external buffers (contingent financing lines, borrowing arrangements).
  - Explicit proposal quote:
    - "For countries with deepening financial markets, and where reserve issues are relevant, the assessment of reserve adequacy for precautionary purposes would include a discussion of relevant metrics, including the Fund’s ARA. Country specific analysis, where necessary, could complement the assessment."

### Capital controls — Box 2 (measuring controls and impact)
- Empirical approach:
  - uses three de jure indices (Quinn, IMF share, Chinn-Ito), normalized to range 0–1 (lower numbers indicate stronger controls); countries "with indices in the top quartile" identified as those with most binding measures.
  - combine indices by median or "2 out of 3" to moderate extremes.
- Key empirical findings:
  - countries identified as having capital controls experience fewer and less extreme outflows during exchange market pressure events;
  - distributions of risk factors (broad money, short-term debt, other external liabilities) during EMP for strict control countries lie to the right of full sample distribution (less extreme);
  - pattern robust to threshold and index choices.
- Measurement caveats:
  - de jure indices imperfect; de facto measures preferable but not directly available and may measure openness rather than legislated controls.
- Policy implication:
  - combine multiple indices and present both unadjusted and adjusted metrics where CFMs exist; discuss likely liberalization speed if relevant.

### Dollarization — Box 4 (impact on crisis probability and cost)
- Literature mixed on whether dollarization raises crisis probability or crisis costs; findings vary by study.
- IMF staff empirical summary:
  - at most a weak link between dollarization and the probability or cost of external crises.
  - probit regressions: dollarization has at most a modest impact — "Two percentage points for a one standard deviation increase in dollarization for the median country."
  - pooled OLS growth regressions: no empirically significant direct link between dollarization and growth in EMs; depreciation has marginally higher contractionary effect in more dollarized economies.
- Mechanisms that may mitigate dollarization risks:
  - higher bank buffers in more dollarized economies,
  - greater foreign bank ownership,
  - evidence that deposit dollarization is associated with higher banks’ holdings of foreign assets and liquidity buffers.

### Low‑income countries (LICs) and constrained market access
- Adequacy for LICs:
  - approach focuses on precautionary motive and assumes risk neutrality; country judgment required.
  - Adequate levels calibrated by sub-groups: resource-rich exporters (RRs), frontier markets (FM), and SSA sub-groups.
  - Adequacy higher for fixed exchange rate regimes and for RRs; frontier markets require relatively lower reserves.
- Cost and measurement challenges:
  - three suggested proxies for cost depending on market structure (sovereign borrowing yield; liquid government bond return adjusted for exchange risk; MPK).
  - thin or distorted markets complicate measurement.
- Application guidance:
  - LICs with market access can supplement with EM-type metrics to capture capital flight risks.
  - methodology complements existing methods (e.g., three-month import rule) and could be used in Article IV consultations.

### Empirical observations and feedback effects on cost of reserves
- Empirical notes:
  - regression coefficients reported for EMBI spreads and marginal cost calculations: βR = -0.380 and βD = +0.327 (as referenced).
  - reserve valuation changes can offset rising spreads; currency depreciation can generate revaluation gains/losses that affect net cost.
- Feedback effects (Box 5 summary):
  - accumulating reserves by issuing external foreign currency debt can overstate net financial cost if the effect of reserves lowering sovereign spreads is ignored.
  - changes in reserves-to-debt ratios and ownership structures can alter local currency spreads and the marginal cost of reserves.
  - expected normalization of US policy may lower valuation gains and raise costs.

### Directors’ discussion points and operational proposals
- Questions for Directors include:
  - agree on flexibility in depth and emphasis of reserve adequacy assessment in Article IV reports;
  - agree that where reserve adequacy issues are important, Article IV reports should discuss precautionary and non-precautionary motives and cost of reserves;
  - preference between standard per-capita income classification vs maturity-based classification developed in this paper;
  - view on scenario analysis for mature (non-reserve) advanced economies and need for precautionary buffers;
  - view that DFM/EM discussions should use a range of indicators including ARA EM metric and proposed adjustments for commodity-intensive economies and CFMs;
  - agreement with framework for LICs with limited market access;
  - usefulness of a guidance note to staff on reserve adequacy issues.
- Proposal options on classification:
  - Option 1: continue with standard classification.
  - Option 2: adopt maturity-based classification (MMA, DFM, CMA) with flexibility and justification for borderline countries.

### Annex highlights and quantitative results
- Annex I (relative reserves and crisis probability): selected probit regression coefficients reported (International reserves over GDP: -6.192***, -7.664***, -8.316***; Ratio of reserves over GDP to regional peers: 0.703**; interaction terms and other covariates listed) — number of samples across columns: 860; Log-Likelihoods: -109.23, -107.39, -106.65; Psedu-R square: 0.119, 0.125, 0.124.
- Annex III (probit model on impact of capital controls on EMP): key coefficients include Capital controls: 5.956*** (t-stat 5.343), International reserves: -1.811*** (t-stat -2.597); number of observations: 844, 813; Log likelihood: -429.21, -403.40; Psedo R-squared: 0.071, 0.077.
- Annex IV (commodity intensity): price elasticity of fuel exports around -0.17; importers elasticity about -0.31 but offset by interaction terms, yielding negligible net sensitivity when controls included.
- Annex V (Dynamic Reserve Assessment):
  - forward-looking application of ARA metric using desk projections (reserves, short-term debt, broad money, exports from latest WEO; portfolio equity and M&L-term debt constructed from IIP and WEO flows).
  - label components: TX, BM, SDM, PEL, MLTD; outputs include Reserves (USD billion) and Reserves (% of Metric, rhs).
  - applied to Mexico and South Africa: for most EMs the relative position vis-à-vis the IMF adequacy metric does not change in projection period; Mexico and South Africa noted as exceptions.

*Source: EXECUTIVE SUMMARY and excerpts from "ASSESSING RESERVE ADEQUACY — SPECIFIC PROPOSALS" (IMF), December 19, 2014.*

### EXECUTIVE SUMMARY

### _121914 - EXECUTIVE SUMMARY

### Role and trade-offs of reserves
- Reserves provide insurance against shocks and, in conjunction with sound policies, can help reduce the likelihood of balance of payment crises and preserve economic and financial stability.
- Reserves can result from both precautionary and non-precautionary policy objectives and institutional settings.
- Benefits: engender confidence in the national currency, counter disorderly market conditions, support the conduct of monetary policy, build assets for intergenerational purposes, influence the exchange rate, and provide space to respond to shocks and prevent disorderly market conditions.
- Costs and risks: reserves generally yield lower returns than alternative uses; sizable and persistent one-sided intervention can move an exchange rate far from its equilibrium, aggravating external imbalances and creating potential spillovers.

### Purpose and scope of the paper
- Aim: bring together recent Fund work on reserve adequacy issues to strengthen discussion in bilateral surveillance and respond to the 2012 IEO evaluation recommendation that reserve assessments in bilateral surveillance reports should be more detailed and reflect country circumstances.
- Proposal: where warranted, individual country Article IV reports include:
  - a fuller discussion of the authorities’ stated objectives (precautionary and non-precautionary) for holding reserves;
  - an assessment of the reserve needs for precautionary purposes;
  - a discussion of the cost of reserves.
- Emphasis on evenhandedness: countries with similar circumstances are to be assessed in similar ways, with depth and emphasis varying depending on country conditions and needs.
- Scope limitation: focus on reserve adequacy issues (precautionary purposes) and not on the broader topics covered in other Fund work (e.g., The Role of Exchange Rate Intervention: Issues and Experiences; the Fund’s institutional view on capital flows; reserve accumulation in a multilateral context).

### Classification of economies and methodology
- Reserve needs for precautionary purposes depend on economic and financial structure.
- Suggested classification for reserve adequacy purposes:
  - mature markets (MMA),
  - deepening financial markets (DFM),
  - constrained market access (CMA).
- These groups largely correspond to commonly used per capita income classification.
- Within each group, methodologies are developed to help reserve adequacy assessments for precautionary purposes.
- Recognition that no single indicator or model can capture the complex set of factors determining reserve adequacy; recommendation that all relevant indicators be used as a starting point and that country-specific analysis further tailor the discussion.

### Reserve adequacy in Fund surveillance
- Surveillance Guidance Note: a discussion of a country’s reserves holdings is a key element of the external stability assessment; Article IV staff reports would generally report a country’s reserves position and include an assessment of whether it is adequate in view of its specific characteristics and vulnerabilities.
- Depth of assessment depends on criticality: deeper discussion where reserve adequacy issues are important for a member’s balance of payments stability and/or global stability.
- Emphasis adjustments:
  - Greater emphasis on precautionary reserve adequacy where reserves are relatively low.
  - Greater emphasis on non-precautionary motives and cost of reserves where reserves are relatively large.

### Precautionary motives and metrics
- Assessing adequacy for precautionary purposes provides a useful starting point to ground reserve discussions.
- Survey finding: about three-quarters of respondent country authorities viewed precautionary liquidity needs as the critical reason to hold reserves.
- Empirical evidence: reserves reduce the likelihood of balance of payments pressure in EMs.
- Advanced market economies (AMs) also used reserves during the global financial crisis to limit market pressures and dysfunction.
- Several simple metrics are widely used for reserve adequacy assessments and comparison; metrics serve as practical starting points but may vary in appropriateness depending on country circumstances.

### Forward-looking assessments and complementary buffers
- Reserve adequacy assessments should be forward looking and consider how reserve needs could evolve over the medium term, since reserve positions can take time to adjust.
- Analyses could draw on expected evolution of factors driving reserve need (e.g., changes in export earnings or external liabilities) and anticipated drains (e.g., maturing forward/swap contracts).
- Examples of dynamic analysis for South Africa and Mexico are provided in Annex V.
- External buffers beyond reserves (e.g., central bank swap lines and contingent IFI facilities) have reserve-like features and should be considered in discussions; however, these buffers differ from reserves in availability and permanence.

### Implications for Article IV consultations and policy advice
- Regular discussion of reserve adequacy in Article IV consultations is valuable to reassess authorities’ and staff’s views in light of domestic and external developments.
- Reserve adequacy considerations can deepen discussions on related policies; e.g., large and sustained foreign exchange intervention that risks draining reserves below precautionary levels would signal need to recalibrate policies.
- The proposals aim to strengthen discussion on external risks and buffers and the interaction of reserves with other policies and institutional settings.
- Methodology is intended primarily for bilateral surveillance but is applicable outside Fund surveillance work.

*Source: EXECUTIVE SUMMARY, December 19, 2014*

### 12. Where relevant, a discussion on reserve holdings would reflect the authorities’ non-

### 12. Where relevant, a discussion on reserve holdings would reflect the authorities’ non-

### Non‑precautionary motives for reserve accumulation
- Non-precautionary objectives, including intangible benefits which may be difficult to quantify, can be important factors for reserve holdings.
- Examples of non-precautionary motives:
  - Foreign exchange intervention under a fixed exchange regime or interventions to achieve an inflation target if other transmission channels (such as credit or interest rate) are ineffective.6
  - Foreign assets held as part of a country’s savings to ensure intergenerational equity, notably in economies endowed with non-renewable resources.7
  - Reserve accumulation as a by-product of export-led growth strategies that rely on sterilized intervention to enhance external competitiveness.8
- Where these non-precautionary issues are important (as discussed in paragraph 7), Article IV reports should reflect the authorities’ primary non-precautionary reasons for reserve accumulation following staff’s discussion with the authorities.

### The cost of reserves
- When Article IV consultations focus on reserve adequacy issues, the financial and opportunity cost of reserves would likely be an important topic for discussion.
- Any assessment should consider both:
  - The benefits of reserves (proxied by adequacy), and
  - The costs of reserves.
- Sections IV and V of the source provide a general framework to support discussions on the cost of reserves.
- Where reserve accumulation can have important outward spillovers, these should be discussed in bilateral and multilateral reports.
  - The Integrated Surveillance Decision requires Article IV staff reports to discuss outward spillovers where a member’s policies do not promote internal or external stability and/or where they lead or may lead to spillovers significant enough to influence the effective operation of the international monetary system.
  - Outward externalities of reserve holdings should also be discussed in multilateral reports—such as the annual Spillovers and External Sector Reports—for multilaterally consistent treatment.

### Proposal for bilateral surveillance
- As part of the external stability assessment of a member, Article IV reports would generally include a discussion on reserve adequacy, reflecting aspects relevant for that country.
- The discussion would include:
  - Adequacy of reserves for precautionary purposes,
  - The authorities’ stated non-precautionary motives for holding reserves, where relevant,
  - The cost of reserves.
- Staff should use judgment in deciding the depth and emphasis of the discussion depending on country circumstances.

### Can relative reserve holdings affect currency crisis probabilities in EMs? (Box summary)
- The role of international reserves in reducing the probability of a crisis is one rationale for accumulation.
- A key question: whether crisis-reduction reflects reserves’ absolute size as a liquidity buffer or their relative size versus peers.
- Although accumulating reserves helps limit currency crisis in EMs, their marginal benefits become smaller as reserves rise (including relative to regional peers).
- Empirically, controlling for relative reserve size, relative reserve holdings are, in themselves, neither key determinants of currency crises nor of private agents’ decisions to remain invested in a country.
- Chart/text labels and phrases preserved exactly from source:
  - "Reserves < regional peers"
  - "Reserves > regional peers"
  - "Reserves > 1.5*regional peers"
  - "Coefficients of Reserves in Currency Crisis Regression"

### Classification of economies for reserve adequacy assessments
- Reserve adequacy assessments should be attuned to differences across advanced, emerging, and low-income countries.
  - In EMs, reserves are associated with lower risks of a currency crisis, although marginal benefits decline at high levels.
  - In advanced economies, reserve buffers are associated with a lower risk of banking crises and market dysfunction.
  - In low-income countries, reserves are associated with the ability to smooth domestic absorption to current account shocks.
- Differences reflect diverse exposure and tolerance to external risks; tolerance depends on market depth, robustness of market liquidity, and economic flexibility.
- Methodology used to classify countries:
  1. Separate countries by extent of market access into:
     - Market access (MA) and
     - Constrained market access (CMAs).
     - Indicators related to durability and depth of market access include public sector issuance in the last three to five years, sovereign debt rating, borrowing in international markets (including through government guarantees)—some of which are also used in PRGT eligibility.9
  2. Market access countries further divided into:
     - Mature markets (MMA) and
     - Deepening financial markets (DFM),
     on the basis of two dimensions from ARA (2013):
     - External financial flexibility:
       - Variables include bid-ask spreads in FX markets (median of daily data in each year), external financial account openness (Lane & Milesi-Ferretti index), and financial market efficiency index (WEF).10
     - Economic flexibility:
       - Variables include goods market efficiency index,11 labor market flexibility index,12 and sovereign rating (average of S&P’s and Moody’s ratings of long-term foreign currency debt).
- Cluster analysis produced specific country groupings using sample of countries that do not issue a reserve currency and are outside a currency union.
- Results and robustness:
  - A country with higher scores in each dimension is interpreted as a more mature market economy.
  - Seven countries close to the dividing line: Chile, Malaysia, Czech Republic, Israel (above the line), and Poland, Peru, Korea (below the line).14
  - The aggregated maturity measure correlates with (the log of) per capita income with correlation above 0.6.
  - Robustness statements: results robust to alternative aggregations, clustering algorithms (K-means, K-median, Ward’s linkage correlations 0.99), and low misclassification error (< 2 percent) in discriminant analysis.13,14,15

### Proposal options to the Board on classification
- Given the large overlap between the standard and the "maturity" classification, present two options:
  - Option 1: Continue to assess reserve needs and adequacy along the lines of the standard classification.
  - Option 2: Classify countries on the basis of financial and economic flexibility and degree of market access for reserve adequacy purposes. Under this option:
    - Countries divided into three groups: mature markets, deepening financial markets, and constrained market access economies.
    - For countries close to the dividing line, country teams have flexibility to decide classification and must justify their decision in Article IV reports based on relevant characteristics and external risks.

### Adequacy considerations by type of economy — Mature Markets
- Before the global financial crisis, little attention was paid to precautionary reserve needs in mature market economies.16
- The global financial crisis showed mature markets can face FX and funding market stress:
  - During 2008, financial institutions in some mature markets were shut out from funding markets, including the FX swap market.
  - The implied US dollar FX swap rate rose to record high levels; the U.S. dollar–libor spread widened sharply from near zero as market transactions froze.17
- Episodes of FX market dysfunction frequently coincide with banking stress; the two processes are likely self‑reinforcing.
- Possible foreign exchange funding needs during market dysfunction may extend beyond banks to non-bank financial and non-financial corporates.
- In extreme periods of market dysfunction, mature economies have used reserves to protect financial stability.18
- A number of mature economies increased their reserves after 2008.19
- The need for reserve buffers differs between:
  - Reserve currency issuers (and those with predictable access to reserve currencies) — unlikely to need sizable reserves for precautionary purposes because assets can be swapped into any other currency at any time.20
  - Non-reserve issuers without predictable access — external buffers, including reserves, can provide insurance against market dysfunction.

*Source: Assessing Reserve Adequacy — Specific Proposals (excerpts provided in the content unit).*

### 26. To assess potential buffer needs, many non-reserve advanced countries rely on

### 26. To assess potential buffer needs, many non-reserve advanced countries rely on

### Scenario analysis for mature (non-reserve) advanced economies
- Many mature market authorities use scenario analysis as the main tool for assessing reserve adequacy (ARA (2013) and staff discussions).
- Scenarios typically center on:
  - risks of market dysfunction (duration of dysfunction; extent of market liquidity that could dry up),
  - risks to bank and nonbank balance sheets from FX funding shortfalls.
- Relevant indicators cited by respondents include foreign exchange market turnover, foreign liabilities, and short-term external debt.
- Where detailed bank and market data are limited or markets prove less liquid in stress, scenario analysis is seen as the most fruitful analytical tool to assess precautionary reserve needs.

### Model and data gaps
- Challenges:
  - Difficulty modeling market dysfunction and liquidity needs given limited historical experience.
  - Detailed bank and market data needed for a general metric are often not publicly available.
- Implication:
  - A standardized metric is complicated to construct for mature economies; scenario analysis is therefore preferred.

### Proposed application for mature-market economies
- Scenario analysis can approximate FX funding needs relative to existing bank and nonbank buffers, calibrated using:
  - available historical information on trading liquidity and turnover,
  - market participant behavior,
  - short-term funding needs,
  - assumptions on adverse shocks.
- Article IV consultations:
  - Should seek to discuss reserve needs based on scenario analysis when a deeper assessment is warranted.
  - Staff should engage authorities on: the authorities’ reserve adequacy framework, dominant risks, possible reserve needs to stabilize markets, and costs of holding reserves.
- Explicit proposal:
  - "Mature market economies without a reserve currency or automatic access to reserve currencies through standing swap lines have a need for reserve buffers."
  - Where reserve adequacy issues are relevant in the external sector assessment, Article IV staff reports are expected to discuss the authorities’ reserve adequacy framework, including risks, possible reserve needs, and costs associated to holding reserves.

### Metrics of reserve adequacy for economies with deepening financial markets — traditional metrics
- Import cover:
  - Measured in months of prospective imports; "three months’ coverage" is typically used as a benchmark for less open capital account countries.
- Reserves to short-term debt (ST Debt):
  - Key indicator of crisis risk for market-access countries.
  - The “Greenspan-Guidotti” rule: 100 percent cover of Short-term Debt.
- Reserves to broad money (M2):
  - Used for countries with large banking sectors and very open capital accounts to capture capital flight risks.
  - Upper end of a prudent range typically set at 20 percent.
- Combination metrics:
  - Expanded Greenspan-Guidotti: ST Debt plus current account deficit (if in deficit) to reflect potential 12-month financing need.
  - Wijnholds and Kapteyn (2001): uses ST Debt and M2, taking into account exchange rate regimes and country risk.

### Optimal reserve models and their implications
- Jeanne and Rancière (2006) model:
  - Balances economic cost of a sudden stop (output/consumption loss) with opportunity cost of holding reserves and risk aversion.
  - Baseline calibration suggests many EMs would optimally hold reserves around 80-100 percent of short-term debt plus the current account deficit and between 75 to 150 percent of the ARA EM metric.
  - Sensitivity: optimal reserves vary considerably with assumptions. Parameter ranges used in sensitivity analysis include:
    - risk aversion from 2 to 4,
    - probability of a sudden stop from 10% to 15%,
    - output loss from 6.5% to 10% (country-specific output loss used if outside 6.5%-10% band).
  - With zero liquidity premium and no output loss, the model reduces to the Greenspan-Guidotti rule.

### The ARA (EM) composite metric (design and performance)
- Rationale:
  - Past crises involved multiple market pressure channels; a broad metric can capture multiple potential drains on reserves.
- Components (four drains on the balance of payments):
  - (i) export income — potential loss from a drop in external demand or terms of trade shock;
  - (ii) broad money — captures potential resident capital flight via liquidation of highly liquid domestic assets;
  - (iii) short-term debt — reflects debt rollover risks;
  - (iv) other liabilities — reflects other portfolio outflows.
- Weighting:
  - Relative risk weights for each component are based on the 10th percentile of observed outflows from EMs during exchange market pressure episodes.
  - Weights were amended in ARA (2013) (weights on “other liabilities” were raised by 5 percentage points in ARA (2013) compared with earlier versions).
- Adequacy benchmark:
  - Reserves in the range of 100-150 percent of the composite (EM) metric are considered broadly adequate for precautionary purposes.
  - A range is used (rather than a point estimate) to reflect uncertainty in estimating balance of payments risks.
- Empirical performance:
  - ARA (2013) showed the EM metric outperformed traditional metrics in predicting market pressure events and in explaining consumption smoothing during stress events.
  - The EM metric captures broader coverage of balance of payments risks and can better reflect risks from rising external liabilities driven by capital inflows and global factors.

### Proposed application for countries with deepening financial markets
- Staff should use adequacy metrics best suited to country characteristics; the IMF ARA metric is recommended for most market-access economies because of its broad coverage.
- Country-specific analysis:
  - Econometric or scenario analysis can supplement metrics to capture additional risks/drains on reserves (e.g., swap or forward transactions, “encumbered” reserves).
  - Consider availability of additional external buffers (contingent financing lines, borrowing arrangements).
- Explicit proposal:
  - "For countries with deepening financial markets, and where reserve issues are relevant, the assessment of reserve adequacy for precautionary purposes would include a discussion of relevant metrics, including the Fund’s ARA. Country specific analysis, where necessary, could complement the assessment."

### Specific operational issues — capital controls and metric adjustments
- Empirical findings:
  - Capital controls (capital flow management measures) can reduce outflows and the probability of exchange market pressure (EMP) events.
  - Example estimate: changing severity of controls from “low” to “moderate” would reduce debt securities outflows and FDI plus equity outflows per capita (US$ base) by about 25 percent and 30 percent, respectively (Binici, Hutchinson, and Schindler (2010) as reported).
- Metric adjustments for capital controls:
  - Where countries have CFMs on residents, the ARA metric weight on broad money should be lowered to reflect reduced resident flight risk.
  - Where countries maintain clear controls on the exit of non-resident assets (minimum holding periods for securities, approval requirements, taxes discouraging early redemptions), the weight on “other liabilities” could be halved (as discussed in ARA (2013)).
  - In cases of CFMs, both unadjusted and adjusted metrics should be presented.
  - If liberalization is a likely near-term prospect, the speed of liberalization and supportive macro policies during the transition should be discussed in Article IV consultations.

*Source: ASSESSING RESERVE ADEQUACY — SPECIFIC PROPOSALS (IMF) — Extracted content unit _121914 - 26. To assess potential buffer needs, many non-reserve advanced countries rely on*

### Box 2. Measuring Capital Controls and their Impact

### Box 2. Measuring Capital Controls and their Impact

### Objective and empirical approach
- Provides new estimates of the impact of capital controls on external pressures, focusing on:
  - Implications of controls on the incidence of stress (exchange market pressure).
  - Implications on the distribution of outflows during such events.
- Empirical focus on three commonly used de jure measures of controls on outflows:
  - Quinn (used in EBA assessments).
  - IMF share (developed by MCM and used in IMF (2012)).
  - Chinn-Ito.
- Each measure is based on the Fund’s Annual Report on Exchange Arrangements and Exchange Restrictions.
- De jure indices were normalized so that all three measures range from 0 to 1, where lower numbers indicate stronger controls.
- Countries with the most binding measures are identified as those "with indices in the top quartile."
- Rationale for combining indices:
  - Use of the median, or 2 out of 3, of these measures to moderate extreme values from any single index.

### Measurement caveats and limitations
- De jure versus de facto:
  - De facto measures of capital controls would be preferable but are not directly available and are often approximated by measures based on external assets and liabilities.
  - Such de facto proxies measure external and financial openness and may bear little relation to legislated controls (see Annex II).
- Specific limitations of indices:
  - Chinn-Ito index captures both inflows and outflows and information on outflows cannot be stripped out. (Footnote 1)
  - The quartile threshold choice is arbitrary but provides a set of observations of countries with relatively tight capital controls. (Footnote 2)
  - Indices may underestimate the extent and pace of liberalization where gradual or partial relaxation of thresholds occurs. (Footnote 3)

### Key empirical findings
- In countries identified as having capital controls:
  - There are fewer outflows during exchange market pressure events.
  - The distributions of various risk factors (e.g., broad money, short-term debt, or other external liabilities) during periods of exchange market pressure for countries with strict capital controls — as well as the 10th percentile points — lie to the right of the distribution of the whole sample (the text chart shows this for broad money).
  - This pattern is robust to the choice of threshold for “strict capital controls.”
  - Testing robustness by raising cutoff for controls to include countries with more liberal regimes increases sample size but leads to the same conclusion: the ‘high’ capital controls distribution indicates considerably less extreme events than the ‘low’ capital controls.
  - A similar pattern holds for those with flexible regimes.
- Robustness and interpretation:
  - Combining the three indices by median (2 out of 3) provides some comfort that extreme values from one index are moderated by the others.
  - Thresholds used correspond to specific index descriptions:
    - For the Quinn measure: “approval required, sometimes granted.”
    - For the IMF share measure: “controls on ¾ transactions with specific financial sector provisions.” (Footnote 2)

### Policy implications and usage
- The empirical results suggest that legislated capital controls, as captured by de jure indices, are associated with fewer and less extreme outflows during exchange market pressure events.
- Measurement guidance:
  - Given limitations of de jure indices, combining multiple indices (median/2-out-of-3) helps mitigate index-specific extremes.
  - Recognize the potential understatement of liberalization speed in indices and treat index values accordingly in analysis and discussions.

*Source: Box 2. Measuring Capital Controls and their Impact, Assessing Reserve Adequacy — Specific Proposals (IMF).*

### Box 4. Impact of Dollarization on Crisis Probability and Cost

### Box 4. Impact of Dollarization on Crisis Probability and Cost

### Literature evidence on dollarization and crisis risk
- Mixed findings across studies:
  - Levy Yeyati (2006): devaluation raises the risk of a banking crisis in the presence of dollarization (balance sheet channel via exchange rate changes).
  - Calvo, Izquierdo, and Loo-Kung (2012): following a large depreciation, crisis risk can result from the rise in the value of FX-denominated liabilities.
  - Arteta (2003): fails to find strong support for dollarization raising banking or currency crisis risk.
  - Honig (2006): finds weak evidence of a positive association between banking crises and unofficial dollarization.
- Evidence on the severity (contractionary costs) of crises in dollarized economies is also mixed:
  - Arteta (2003): fails to find evidence that dollarization increases contractionary costs; notes potential buffer roles of dollarization (deposit dollarization insulating deposits from a currency crash; credit dollarization transferring credit risk from banks to firms, encouraging better risk management and hedging).
  - Chitu (2012): focusing on the global financial crisis, finds unofficial loan dollarization was an important determinant of crisis severity (output collapse between 2007 and 2009) in a large number of EMs, transmitted through limited lender-of-last-resort ability and currency mismatches.

### New IMF staff empirical findings (summary)
- Overall conclusion: staff empirical work indicates at most a weak link between dollarization and the probability or the cost of external crises.
  - The analysis here is based on deposit dollarization, but the results are the same if loan dollarization is used instead.
- Probit regressions of currency-crisis probability (with standard covariates such as net external asset position, international reserves, VIX, fiscal balance) find:
  - Dollarization has at most a modest impact.
  - Quantified impact: Two percentage points for a one standard deviation increase in dollarization for the median country.
- Growth regressions (pooled OLS) controlling for currency and banking crises, dollarization, reserves, banks’ own buffers, and other macro variables find:
  - No empirically significant direct link between dollarization and growth in EMs.
  - Reserves, banks’ buffers and other main macro variables controlled for.
  - Nonetheless, the contractionary effect of exchange rate depreciation is marginally higher in more dollarized economies.

### Mechanisms, buffers, and cross-country influences
- Possible explanations for the weak empirical link:
  - Higher buffers in banks in more dollarized economies.
  - Larger degree of foreign bank ownership providing resilience.
- Supporting empirical findings cited:
  - Dinger (2009): foreign banks help significantly in reducing the risk of aggregate liquidity shortages in some EMs.
  - Levy Yeyati (2008): deposit dollarization is robustly related to commercial banks’ holding of foreign assets.
  - Deléchat, and others (2012): deposit dollarization is robustly and significantly associated with higher liquidity buffers in a number of fully and partially dollarized economies.

### Key takeaways and implications
- Dollarization does not exhibit a strong, consistent empirical link to:
  - Higher probability of currency or banking crises (at most modest impact in probit models).
  - Lower growth in EMs (no significant direct impact in pooled OLS growth regressions).
- Caveats and conditional findings:
  - Exchange rate depreciations have a marginally higher contractionary effect in more dollarized economies.
  - Buffering factors (bank foreign assets, higher liquidity buffers, foreign bank presence) may mitigate risks associated with dollarization.

*Source: Box 4. Impact of Dollarization on Crisis Probability and Cost, from the provided IMF material.*

### 68. The findings confirm the effectiveness of reserves in mitigating the domestic effects of

### _121914 - 68. The findings confirm the effectiveness of reserves in mitigating the domestic effects of

### Effectiveness of reserves and vulnerability factors
- Reserves are effective in mitigating the domestic effects of external shocks.
- Other factors affect vulnerability to a crisis:
  - Resource-rich exporters (RRs) experience larger domestic impacts of external shocks due to dependence on commodity revenues.
  - Economies with fixed exchange rate regimes need substantially higher reserve levels than those that allow the exchange rate to act as a shock absorber.

### The cost of holding reserves — conceptual approaches
- Three conceptual approaches to determine the cost of holding reserves (not all relevant for all LICs):
  - The external funding cost for economies beginning to access capital markets, net of the estimated return earned on foreign assets held as foreign reserves.
  - The sterilization cost incurred by the central bank when it purchases foreign exchange from the market, netted against the return earned on foreign reserve assets; comparing an interest cost denominated in domestic currency with the rate of return on foreign assets requires adjustment for exchange rate risk.
  - The opportunity cost to the economy as a whole of devoting investible resources into holdings of liquid foreign financial assets, using the marginal productivity of capital (MPK) as an estimate of potential returns on foregone physical investment less returns earned on liquid foreign assets; for some cases (including several RRs) the opportunity cost may be viewed as the marginal productivity of public investment.

### Measurement challenges and suggested proxies
- Measuring the cost of holding reserves is challenging due to difficulty in choosing and quantifying appropriate proxies; thin, distorted, segmented markets reduce the informational importance of interest rates.
- Three suggested proxies for the cost of holding reserves:
  - The yield on sovereign borrowing for countries with limited market access (market-based indicator capturing sovereign risk).
  - The return on the most liquid longer-term government bonds adjusted for exchange rate risk for countries with liquid government securities markets (proxy for sterilization cost).
  - The marginal product of capital (MPK) to capture the opportunity cost of foregone fixed investment where financial markets are thin or underdeveloped; MPK depends on investment as a percent of GDP, output, the depreciation rate, and the share of capital stock. MPK (public capital) could be useful for RRs but measurement and data issues may preclude country-specific estimates.

### Marginal cost of holding reserves (empirical notes)
- The marginal cost of holding reserves is obtained by netting off the return on reserve assets.
- Central banks traditionally invest in short-term bank deposits and government securities and typically earn a return on foreign exchange claims; in recent years these asset returns have turned negative in real terms.
- The return on foreign exchange claims is estimated as the highest interest that could be earned from holding either government debt security or foreign bank deposits for the constituent currency.
- The marginal cost of holding reserves ranges from around 4 to 6 percent using alternative cost proxies.

### Determining adequate levels of reserves
- Estimated results suggest scope to raise reserve levels in a sizeable number of LICs with fixed exchange rate regimes; results are illustrative not prescriptive.
- Adequate levels are calibrated for RRs, frontier markets (FM), and SSA sub-groups to capture heterogeneity:
  - Adequate level is higher for fixed exchange rate regimes due to greater vulnerability to shocks.
  - Adequate level for frontier markets is relatively lower: cost of holding reserves lower due to market access, institutions stronger, exposure to shocks smaller.
  - Adequate level for RRs is higher than for other sub-groups because of more adverse domestic impact of external shocks.
- The methodology focuses exclusively on the precautionary motive for holding reserves and assumes risk neutrality; countries may need to hold higher reserves than indicated.

### Application to LICs and proposal
- Country judgment required; LIC country team survey called for customizing the approach to country circumstances and structured adjustment of parameters and further operational guidance.
- LICs with market access could supplement reserve adequacy results with EM-type metrics to capture capital flight risks.
- Proposal summary for Low-Income and Credit Constrained Economies:
  - Low share of non-concessional debt implies liquidity drains differ from many EMs (mainly sudden stops for portfolio investment).
  - Proposed approach balances benefits of holding reserves for crisis prevention and mitigation against opportunity cost, focusing on the precautionary motive.
  - Approach complements existing methods (e.g., three-month import rule) and could be used in Article IV Consultations; LICs with market access may supplement with EM-type metric.

### Cost of reserves for countries with market access (detailed considerations)
- Two main components of the cost of reserves: (i) foregone return on alternative use/asset or cost of issuing paper for sterilization; (ii) foreign currency return on reserves.
- Indicators in literature for first component: external debt servicing cost (opportunity cost of retiring debt), social opportunity cost of public capital, and sterilization cost.
- When reserves are inadequate or barely adequate, marginal cost of financing accumulation is relevant (cost of borrowing reserves or cost of sterilizing acquisition); quasi-fiscal sterilization costs can be high and include anticipated exchange rate valuation losses.
- Where reserves are ample, the net financing or opportunity cost is suitable: difference between local yield of reserves and return on reserve assets, adjusting country yield for effect of higher reserves reducing yields.
- Opportunity cost measures by circumstance:
  - For market access economies with high externally issued foreign currency debt: use external FX-denominated yield (proxy: EMBI spread less endogenous impact of higher marginal reserves on lowering spreads).
  - For market access economies with adequate reserves and local currency debt: local currency bond yield proxy (reflects opportunity cost of retiring local currency debt).
  - For credit constrained/frontier economies: external financing cost approximated by sovereign bond yield capturing sovereign risk; if bond market frictions exist, cross-country currency interest rate swaps may be used.
- The cost of reserves is lower for mature market countries than for countries with deepening financial markets because mature market sovereigns have relatively lower funding costs in both foreign and domestic currencies while return on reserve assets is equal.

### Empirical and illustrative observations
- Figures and regressions referenced:
  - EMBI Spreads and Marginal Cost of Holding Reserves, 2000–13 (median values) show trends; regression coefficients reported: βR = -0.380 and βD = +0.327.
  - Changes of Reserves Valuation chart comparing 2006 and 2012 highlights that currency depreciation can offset rising spreads, making revaluation gains/losses a significant part of reserve costs.
- Box 5 (Costs of Reserves Accumulation: Feedback Effects):
  - Accumulating reserves through issuance of external foreign currency debt can overstate net financial cost if the effect of reserves lowering sovereign spreads is not accounted for.
  - Levy-Yeyati (2008) formulation: external financing cost is a function of sovereign spreads, reserves-to-debt ratio (w), and elasticities of debt and spreads with respect to reserve changes.
  - For the median EM in the first half of the decade, low reserves relative to debt made returns on reserve accumulation high, lowering marginal cost relative to EMBI spreads; trends reversed as reserves more than covered debt.
  - Since the GFC, increases in reserves-to-domestic public debt were associated with decreases in local currency spreads as foreign ownership of local currency bonds increased.
  - Accommodative policies in advanced economies increased quasi-fiscal costs in EMs, but reserves valuation gains have offset rising spreads; expected normalization of US policy may lower valuation gains and raise costs.

### Proposals and operational guidance
- Sterilization and yield-based opportunity costs are useful measures of the marginal cost of reserves; choice should reflect country circumstances (adequacy of reserves, alternative uses, exchange rate relative to fundamentals).
  - Cost of acquiring reserves (sterilization or borrowing costs) most appropriate for countries with low reserve holdings.
  - Net financial (opportunity) cost relevant for countries with market access and adequate reserves; measure may be local or foreign currency yields and should account for anticipated depreciation and any marginal impact of reserves on spreads.

*Source: IMF staff calculations and discussion in "ASSESSING RESERVE ADEQUACY — SPECIFIC PROPOSALS".*

### 79. This paper seeks to advance Fund’s work on the assessment of reserve adequacy in

### _121914 - 79. This paper seeks to advance Fund’s work on the assessment of reserve adequacy in

### Directors' discussion points on reserve adequacy in bilateral surveillance
- Flexibility: Do Directors agree that there should be flexibility in the assessment of reserve adequacy in Article IV reports, tailoring the depth and emphasis of the discussion to a country’s characteristics and circumstances?  
- Coverage where important: Do Directors agree that where reserve adequacy issues are important for a country’s external stability and/or global stability, Article IV reports should include a discussion of the considerations underpinning reserve holdings, including precautionary and non-precautionary motives, and the cost of reserves?  
- Classification approach: Do Directors prefer reserve adequacy to be assessed along the lines of the standard per-capita income classification or see merit in adopting the maturity-based classification developed in this paper?  
- Advanced economies: Do Directors agree that mature economies (advanced economies) need precautionary foreign currency buffers to prevent the risk of disorderly markets? Do Directors view that scenario analysis offers an appropriate tool to assess these countries potential reserve needs?  
- Emerging markets: Do Directors agree that reserve adequacy discussions in economies with deepening financial markets (emerging market countries) should be based on a range of relevant indicators, including the ARA EM metric, supplemented where needed by country specific analysis? Do the proposed adjustments of the ARA and other metrics for commodity intensive economies and for countries with CFMs capture the general characteristics of these economies?  
- Low income countries: Do Directors agree with the framework for assessing reserve adequacy in countries with limited market access (low income countries)?  
- Guidance note: Do Directors continue to see the preparation of a guidance note to staff on reserve adequacy issues, in line with the Management implementation plan (IMF, 2013d), as useful?

### Annex I — Can relative reserve holdings affect currency crisis probabilities in EMs?
- Objective: Investigate effect of relative reserve holding on crisis likelihood using the crisis probability regression model from the ARA (2013); sample extends from the 1980s.  
- Specification: Include a cross term of international reserves and a dummy = 1 when a country’s international reserve is higher than its regional peers (or in specification 3, 1.5 times). If the coefficient is positive, it indicates the higher relative reserves, the smaller marginal impact of international reserves on crisis probability.  
- Key qualitative finding: Relative reserve holdings do not seem a key determinant of private agents’ decisions to remain invested in a country.  
- Regression summary (selected coefficients and significance as reported):  
  - International reserves over GDP: -6.192*** (t-stat -2.717), -7.664*** (t-stat -3.355), -8.316*** (t-stat -3.202)  
  - Ratio of reserves over GDP to regional peers: 0.703** (t-stat 2.384)  
  - International reserves (over GDP)*dummy (=1 if reserve is higher than regional peers): 1.815 (t-stat 0.974)  
  - International reserves (over GDP)*dummy (=1 if reserve is higher than 1.5*regional peers): 4.226** (t-stat 2.143), -1.648 (t-stat -0.629) in alternative specification  
  - Net direct investment: 2.222** (t-stat 2.384), 1.987** (t-stat 2.147), 2.019** (t-stat 2.099)  
  - Net portfolio equity assets: -3.048* (t-stat -1.778), -2.882* (t-stat -1.675), -3.461* (t-stat -1.958)  
  - VIX: 5.600*** (t-stat 3.000), 6.081*** (t-stat 3.180), 6.805*** (t-stat 3.341)  
  - Fiscal balance gap: -9.086** (t-stat -2.199), -9.057** (t-stat -2.191), -9.478** (t-stat -2.275)  
  - Constant: -2.280*** (t-stat -4.566), -2.251*** (t-stat -4.401), -2.767*** (t-stat -4.887)  
  - Number of samples: 860, 860, 860 (across reported columns)  
  - Log-Likelihood: -109.23, -107.39, -106.65 (as reported for columns)  
  - Psedu-R square: 0.119, 0.125, 0.124  
- Interpretation: The cross term becomes statistically significant when the threshold for the dummy is switched to 1.5, although the sign suggests the beneficial marginal impact of reserves is reduced by such high reserve holdings. Marginal benefits of accumulating reserves become smaller as reserves relative to regional peers increase.

### Annex II — Capital control measures: de jure vs de facto
- Measurement types: (i) de jure measures reflect laws and regulations governing controls; (ii) de facto measures attempt to capture stringency of controls.  
- Main de jure indices discussed: Chinn-Ito, Quinn, Schindler (Schindler index available only up to 2005; update expected in 2014), and IMF share (compiled by MCM). Primary source: IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER).  
- Correlation: Despite differences, de jure indices show very strong correlation (around 0.8).  
- Quinn index note: The Quinn index can take only 5 values: 0, 0.5, 1, 1.5 and 2, where large number indicates less controls. Quinn is highly discrete and may be less time variant.  
- De facto indicators: Examples include Lane and Milesi-Ferretti external assets and liabilities indices and portfolio investment assets and liabilities. De facto indicators appear to bear little relation to legislated controls and instead measure financial openness and are influenced by financial development, financial depth, country risk premium, access to international markets, and global financing conditions.  
- Visual findings (as described): De jure and de facto measures can disagree across countries; median measures and ordering of countries differ when using de jure median versus de facto Lane and Milesi-Ferretti index (percent of GDP) and portfolio flows (percent of GDP, average 2011-13).

### Annex II — Impact of variable changes on Exchange Market Pressure (EMP) events
- One standard deviation change in:  
  - International reserves: 4.0 (increase in EMP event probability, percentage points) and 8.9 (alternative reported value)  
  - VIX: 5.3 and 12.1  
  - Fiscal balance: 2.25 and 5.8  
(Note: values reported in tabular/presentational form as "One standard deviation change in" with paired numbers.)

### Annex III — Probit model on impact of capital controls on outflows / EMP events
- Model: Probit model explaining periods of exchange market pressure (EMP), controlling for global factors and country fundamentals; two-step estimation to address endogeneity of controls (instrumented by lagged variables). Variables other than capital controls are one year lagged. Panel probit with time factors.  
- Key qualitative conclusion: Stricter de jure controls mitigate the impact of exchange market pressure. Imposing capital controls could reduce EMP probabilities against some exogenous shocks. Strengthening capital controls (from 0.75 to 0.50 index points) could reduce the marginal impact of lower international reserves, higher uncertainty and more deteriorated fiscal balance on EMP probabilities by more a half (as shown in the presentation).  
- Selected regression coefficients and significance:  
  - Capital controls: 5.956*** (t-stat 5.343), 5.763*** (t-stat 4.934)  
  - International reserves: -1.811*** (t-stat -2.597), -1.688** (t-stat -2.312)  
  - Net FDI position: 1.759*** (t-stat 3.861), 1.826*** (t-stat 3.708)  
  - VIX: 5.168*** (t-stat 5.828), 5.065*** (t-stat 5.442)  
  - Fiscal balance gap: -5.434** (t-stat -2.361) in one specification  
  - Constant: -4.588*** (t-stat -7.351), -4.561*** (t-stat -6.994)  
  - Number of observations: 844, 813 (across specifications)  
  - Log likelihood: -429.21, -403.40  
  - Psedo R-squared: 0.071, 0.077

### Annex IV — Commodity intensity and price sensitivity (fuel as proxy)
- Objective: Capture impact of price shocks on commodities-intensive economies by panel regressions of export and import volumes’ growth on commodity price changes, controlling for trading partners' demand growth, domestic demand growth, REER changes, commodities-intensive indicator, and interaction of indicator with price changes. Sample: annual observations for 36 emerging markets, 1989–2013. Fuel used as main proxy for commodities-dependence. Fuel volumes computed from WITS/UN Comtrade gross trade flows (US$) and average of three spot prices (Dated Brent, West Texas Intermediate, Dubai Fateh) from WEO/GEE. Commodities-intensive indicators based on share of traded fuel in total trade flows.  
- Model selection: Statistical tests broadly favor random effects specification for commodity exporters.  
- Key empirical findings on price elasticity (text table results):  
  - Price elasticity of fuel exports: around -0.17 (relatively small) and statistically zero for subset with bulk export proceeds from oil exports.  
  - Price elasticity for importers: about -0.31 (larger in magnitude) but when controlling for interactive effect (being a commodity-intensive importer times the price change) the interaction offsets most of that impact (+.27), resulting in statistically negligible price sensitivity.  
- Interpretation: Once controlling for relevant macroeconomic variables, trade volumes of commodities-intensive economies present much lower sensitivity to price shocks than those of peers.

*Source: Excerpt from IMF paper "_121914 - 79. This paper seeks to advance Fund’s work on the assessment of reserve adequacy in" (PDF chapter/section).*

### Annex V. Dynamic Reserve Assessment

### Annex V. Dynamic Reserve Assessment

### Overview
- Proposes a forward-looking approach to assess reserve adequacy that evaluates a country’s current reserve position metric in light of the expected path of reserves and key risks.
- Illustrated using the ARA metric.
- Main advantage: its forward-looking nature.

### Methodology
- The dynamic ARA metric relies on desks’ projections of its main components.
- Projections suggested:
  - Changes in foreign exchange reserves, short-term debt, broad money, and exports could be taken directly from the latest WEO.
  - Projections on portfolio equity and medium- and long-term debt could be constructed based on the latest available international investment position data and the WEO projections on the balance-of-payment flows pertaining to these transactions (assuming no valuation changes).
- ARA decomposition labels (as used in the illustrations): Export revenues (TX); Broad money (BM); Short-term Debt (SDM); Portfolio equities (PEL); M&L-term debt (MLTD); Reserves (USD billion); Reserves (% of Metric, rhs).

### Applications and Examples
- Applied to Mexico and South Africa.
- For most emerging markets, the relative position vis-à-vis the IMF adequacy metric does not change in the projection period.
- Noted exceptions:
  - Mexico: changes because of projected changes in international reserves.
  - South Africa: changes because of projected movements in the country-specific components of the ARA EM metric.
- The forward-looking diagnostic can serve as an important surveillance tool for policy discussions with country authorities.

*Source: Annex V. Dynamic Reserve Assessment*

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