Build-Up of Gross Reserves Adequate

The Bank of Jamaica’s (BoJ) Gross International Reserves (GIR) at end of June 2010 amounted to over US$2. 5 billion, representing nearly 20 weeks of projected goods and services imports relative to the international benchmark of 12 weeks.
The stock of Net International Reserve (NIR) at the end of that period was just under US$1. 8 billion, higher than the stock at end of March 2010, but also above the end of June target.
This significant monetary development was highlighted in the recently released Quarterly Monetary Policy Report of the BoJ.
Since the signing of the Stand-By-Arrangement with the International Monetary Fund (IMF) in February, there has been increased interest in the adequacy of BoJ’s foreign currency international reserves. The facility has resulted in significant loan inflows from multilateral financial institutions, and some financial analysts claim that this could have negative economic consequences.
The central bank acknowledged that while an adequate level of reserves would engender confidence by providing sufficient cushion in the event of a balance of payments crisis, “an excessive build-up could have an adverse impact on the Bank’s profitability and ultimately on the national debt”.
Referencing an IMF (1953) policy note, the BoJ Report noted that the international reserves of a country are not adequate until the public, including the international community, thinks they are adequate.
“An adequate level of reserves is one that satisfies some minimum desired precautionary balance, given that higher levels will be relatively more costly for the economy,” the Report noted.
The central bank further explained that the cost of holding the minimum precautionary stock is regarded as the country’s insurance premium.
“Central banks consider a range of factors when determining an appropriate level of international reserves. Countries that employ a fixed exchange rate regime, or operate a managed float, require some amount of international reserve buffer to ensure that the central bank can either defend the prevailing exchange rate, or intervene in the foreign exchange market as the need arises” the Report explained.
A reserve buffer is also necessary in underpinning confidence in the ability of the authorities to discharge their external obligations, particularly in situations where access to external borrowing is curtailed or very expensive. However the Bank admitted that the holding of international reserves, can be costly.
“In the context of a managed float or fixed exchange rate regime, the boost to the domestic money supply from overall reserve accumulation may be sterilised by the central bank. If the interest rates on the central bank’s liabilities are higher than the rates at which the international reserves are invested, this sterilisation will be costly for the authorities. For this reason, excessive accumulation of international reserves is often regarded negatively,” it stated.
In order to determine how much international reserve can be regarded as being adequate, central banks commonly examine a number of factors. The GIR to imports ratio, also referred to as ‘the Import Cover Criterion’ (ICC), is one such measure. It utilises a reserve coverage benchmark of 12 weeks of projected imported goods and services as a critical benchmank.
Twelve weeks of reserve cover is close to the mean and the median of the level of reserves held by IMF member countries, including Jamaica. Another factor is the level of international reserves that would be sufficient to meet foreign debt payments, without the need for new borrowing for one year.
Using these and other technical criteria, the BoJ is of the view that, at current levels, the international reserves are adequate and that the forecast of GIR could be well over eight per cent or (US$188.4 million) higher than the international reserve level of adequacy.
“Given the country’s susceptibility to adverse weather, economic and commodity price shocks, there is the need to hold additional “insurance” above the benchmark. In this context, therefore, the recent gross international reserve accumulation may not be excessive,” the Report said.