Reserve Management (Risk executive report)

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Reserve Management by H. M. Scobie and G. Cagliesi European Economics and Financial Centre, London

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Published by Risk Books, a specialist division of Risk Publications. Haymarket House 28–29 Haymarket London SW1Y 4RX Tel: +44 (0)171 484 9700 Fax: +44 (0)171 930 2238 E-mail: [email protected] Home Page: http://www.riskpublications.com Monadnock Building 53 West Jackson Boulevard Suite 252, Chicago Illinois 60604 USA Tel: 001 312 654 0556 Fax: 001 312 554 0558 © European Economics and Financial Centre 2000 ISBN 899332 82 0 British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Risk Books Commissioning Editor: Conrad Gardner Project editor: Bridie Selley Copy editor: Anne Trevillion Typesetter: Special Edition Printed and bound in Great Britain by Selwood Printing Ltd, Burgess Hill, West Sussex. Covers printed by Lea Printers, Bromley. Conditions of sale All rights reserved. No part of this publication may be reproduced in any material form whether by photocopying or storing in any medium by electronic means whether or not transiently or incidentally to some other use for this publication without the prior written consent of the copyright owner except in accordance with the provisions of the Copyright, Designs and Patents Act 1988 or under the terms of a licence issued by the Copyright Licensing Agency Limited of 90, Tottenham Court Road, London W1P 0LP. Warning: the doing of any unauthorised act in relation to this work may result in both civil and criminal liability. Every effort has been made to ensure the accuracy of the text at the time of publication. However, no responsibility for loss occasioned to any person acting or refraining from acting as a result of the material contained in this publication will be accepted by Financial Engineering Ltd. Many of the product names contained in this publication are registered trade marks, and Risk Books has made every effort to print them with the capitalisation and punctuation used by the trademark owner. For reasons of textual clarity, it is not our house style to use symbols such as â, (r), etc. However, the absence of such symbols should not be taken to indicate absence of trademark protection; anyone wishing to use product names in the public domain should first clear such use with the product owner.

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Contents Foreword

v

Chapter 1 Introduction

1

1.1 Reserves accumulation and its implication

5

1.2 Autonomy of central banks

7

1.3 Transparency of central banks

7

1.4 Responsibility for the management of official reserves

8

1.5 Gold

8

1.6 Aims and objective of this study

9

Chapter 2 Understanding Central Bank Balance Sheets

11

2.1 Conventions and terminology

12

2.2 Definitions of terms used by different central banks

17

2.3 Variation between central banks

17

2.4 Central bank functions versus ministry of finance functions

19

2.5 Disclosure of financial data at the international level: common standards

23

Chapter 3 Motives for Holding Foreign Exchange Reserves

27

3.1 Changes in reserve holdings

27

3.2 Structural Changes in Reserves Policies

31

3.3 Necessary qualifications of a reserve currency

34

3.4 The euro as a reserve currency

34

3.5 Motives for different countries

35

3.6 Objectives of monetary policy

37

3.7 Monetary and exchange-rate policies in Denmark

38

Chapter 4 Composition of Foreign Exchange Reserves

41

4.1 Composition by currency

41

4.2 Composition by type of financial instrument

42

4.3 Shifts into euros

44

Chapter 5 Benchmarks

47

5.1 Definition

47

5.2 Asset allocation practices of central banks

47

5.3 Duration

48

5.4 Trading size of central banks

49

5.5 Some benchmark examples

49

5.6 Changes in benchmarks

53

Chapter 6 Currency Baskets and Official Reserves Policies

55

6.1 Definition

55

6.2 Composition of currency baskets

55

6.3 Abandonment of currency baskets

58

6.4 Special drawing rights

59

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Chapter 7 Options for a Central Bank

61

7.1 Optimality of the level of reserves

61

7.2 Yardsticks for measuring the optimality of reserves

61

7.3 Costs of accumulation of reserves

61

7.4 Monetary policy versus reserve policy

63

Chapter 8 Reserve Management from the Perspective of the EMU Region

69

8.1 Foreign reserves of the euro area

69

8.2 Official reserves of the European Central Bank

71

8.3 Official reserves of the ESCB (European System of Central Banks)

73

Chapter 9 Reserve Management from the Perspective of the Non-EMU Region

79

9.1 Starting value of the euro against other currencies

80

9.2 Developments in foreign exchange reserve positions of the nonEMU countries before and at the launch of the euro

82

9.3 Dollarisation

90

Chapter 10 Some Policy Prescriptions and Future Scenarios: A Global Single Currency

91

10.1 Alternative scenario for EU enlargement

92

10.2 Attractiveness of the dollar for emerging markets

92

10.3 Conduct of monetary policy with a reserve currency

92

10.4 Adoption of one international currency

93

10.5 Cost-saving elements of a global single currency

93

10.6 Benefits of a global single currency

94

10.7 Costs of a global single currency

94

10.8 A global central bank

95

10.9 Use of one currency with the development of e-commerce

95

10.10 Concluding remarks

95

Appendix A—Total Reserves of All Countries as of May 1999

97

Appendix B—Balance Sheets

101

Appendix C—IMF Strengthens Standards for Public Dissemination of Data on International Reserves

151

Background

151

Executive Board discussion

151

Public Information Notices

153

Data template on international reserves/foreign currency liquidity

153

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Foreword Many members of the European Economics and Financial Centre assisted with the preparation of this book. We are indebted to them for their support and assistance. In particular we wish to thank and acknowledge the contributions of the following: B. Allan, T. Kaltio, C. Valeur, S. Francis, A. Minaeva, D. Shah, N. Egorova, A. Kusre and G. Camaray. A survey of central bankers was carried out for the purpose of this study. We are grateful to them for the time and effort they have put into this project and for all the valuable material they have provided us. We would also like to thank the editorial members of Risk Publications, in particular Shân Millie and Conrad Gardner, for their help and support towards the production of this volume. European Economics and Financial Centre The European Economics and Financial Centre is engaged in research and advisory work in the areas of Economics and Finance. It has close contacts with the financial community at large. The EEFC has among its aims and capabilities the establishment of closer links between the practitioner (both in the private and public sector) and the theorist, in the area of economics and finance. The EECF's research projects cover a cross section of topics ranging from issues related to European integration, single currency, behaviour of exchange rates; to different aspects of financial markets, including the derivatives markets, as well as dealing practices and regulatory environments. It also produces macroeconomic studies of different economies in particular examining their structural changes. In addition the Centre runs a number of international symposiums, workshops and courses. The Centre produces many publications—notably journals which include, Economic & Financial Review, Economic & Financial Modelling and Economic & Financial Computing. European Economics and Financial Centre PO Box 2498 London W2 4LE Tel: 0207 229 0402 Fax: 0207 221 5118 E-mail: [email protected]

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1— Introduction Foreign exchange reserve management is an area that is closely guarded and rarely openly discussed by central bankers or reserves officials. For this reason there is a noticeable absence of published information on this subject, considering the significance of reserves holding on the movements of different currencies and the foreign exchange market as a whole. With the objective of working towards, and partially fulfilling, this gap in the literature, this volume attempts to throw more light on reserves policies and management worldwide. There are a number of issues that have been relevant for the production of this report. This includes an understanding of the intricacies of central bank balance sheets. For this reason in an extensive section compiled as Appendix B the balance sheets of the different central banks are presented. This appendix brings to light the substantial variations that exist among central banks. Thus, the reader can observe the diversity of conventions, terminologies and alternative definitions of terms used by these organisations, as well as the disparities between them. This report analyses the motives for holding foreign exchange reserves and explains the notion of "benchmarks" as applied by different central banks. It highlights the features that distinguish the role of central banks from those of ministries of finance with respect to official reserves. It also examines the composition of foreign reserves by type of currency and by type of financial instrument in different corners of the world. The report reviews and puts forward alternative options for a central bank and examines the outlook for currencies globally. Major financial crises occurred in different continents of the world during the latter part of the 1990s, with dire consequences for the economies of the countries concerned. These crises began to erupt in the emerging markets of South-East Asia during 1997, sweeping across this region through the contagion effect and subsequently spreading to South America and Eastern Europe. As a result a great deal more attention has been paid to reserves policy within central banks. Reserve management has become more active as an area of policy and activity within these organisations. Indeed, there is a noticeably increased awareness among monetary authorities of reserves policy. Massive structural changes have been taking place within central banks globally.* One such example is the case of South Korea. In December 1997, at the depth of the financial crisis, the foreign exchange reserves of the Bank of Korea dropped to a mere US$6 billion (though for the year 1997 as a whole the size of the reserves was around US$19 billion). By August 1999 the same central bank's foreign exchange reserves reached some US$66 billion. This is a staggering eleven-fold increase. Table 1.1 shows the magnitude of foreign exchange reserves for the Bank of Korea for the years 1997, 1998 and 1999. It appears that the Bank of Korea may consider raising its foreign exchange reserves even higher to possibly US$100 billion. This build-up of foreign reserves appears to be a pattern that is occurring in other countries of South-East Asia. Table 1.1. Foreign exchange reserves of the Bank of Korea (millions of US dollars)

Foreign exchange reserves

1997

1998

1999*

19,710.4

51,963.1

66,000.0

Source: Bank of Korea, 1999, Annual Report 1998, Seoul, Korea, p. 64. *As of August 1999.

*See

also D. Djukic, 1998, "Banking Sector Restructuring", Economic and Financial Review, 5, no. 2, Summer, p. 79.

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1— Introduction Foreign exchange reserve management is an area that is closely guarded and rarely openly discussed by central bankers or reserves officials. For this reason there is a noticeable absence of published information on this subject, considering the significance of reserves holding on the movements of different currencies and the foreign exchange market as a whole. With the objective of working towards, and partially fulfilling, this gap in the literature, this volume attempts to throw more light on reserves policies and management worldwide. There are a number of issues that have been relevant for the production of this report. This includes an understanding of the intricacies of central bank balance sheets. For this reason in an extensive section compiled as Appendix B the balance sheets of the different central banks are presented. This appendix brings to light the substantial variations that exist among central banks. Thus, the reader can observe the diversity of conventions, terminologies and alternative definitions of terms used by these organisations, as well as the disparities between them. This report analyses the motives for holding foreign exchange reserves and explains the notion of "benchmarks" as applied by different central banks. It highlights the features that distinguish the role of central banks from those of ministries of finance with respect to official reserves. It also examines the composition of foreign reserves by type of currency and by type of financial instrument in different corners of the world. The report reviews and puts forward alternative options for a central bank and examines the outlook for currencies globally. Major financial crises occurred in different continents of the world during the latter part of the 1990s, with dire consequences for the economies of the countries concerned. These crises began to erupt in the emerging markets of South-East Asia during 1997, sweeping across this region through the contagion effect and subsequently spreading to South America and Eastern Europe. As a result a great deal more attention has been paid to reserves policy within central banks. Reserve management has become more active as an area of policy and activity within these organisations. Indeed, there is a noticeably increased awareness among monetary authorities of reserves policy. Massive structural changes have been taking place within central banks globally.* One such example is the case of South Korea. In December 1997, at the depth of the financial crisis, the foreign exchange reserves of the Bank of Korea dropped to a mere US$6 billion (though for the year 1997 as a whole the size of the reserves was around US$19 billion). By August 1999 the same central bank's foreign exchange reserves reached some US$66 billion. This is a staggering eleven-fold increase. Table 1.1 shows the magnitude of foreign exchange reserves for the Bank of Korea for the years 1997, 1998 and 1999. It appears that the Bank of Korea may consider raising its foreign exchange reserves even higher to possibly US$100 billion. This build-up of foreign reserves appears to be a pattern that is occurring in other countries of South-East Asia. Table 1.1. Foreign exchange reserves of the Bank of Korea (millions of US dollars)

Foreign exchange reserves

1997

1998

1999*

19,710.4

51,963.1

66,000.0

Source: Bank of Korea, 1999, Annual Report 1998, Seoul, Korea, p. 64. *As of August 1999.

*See

also D. Djukic, 1998, "Banking Sector Restructuring", Economic and Financial Review, 5, no. 2, Summer, p. 79.

Page

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Figure 1.1 Foreign exchange reserves of Korea. Source: Bank of Korea, 1999, Annual Report 1998, Seoul, Korea, p. 80.

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Figure 1.3 Foreign exchange reserves of China Sources: IMF, 1997, International Financial Statistics, L, no. 10, October, and IMF, 1999, International Financial Statistics, LII, no. 8, August.

Figure 1.4 Foreign exchange reserves of Brazil Sources: IMF, 1997, International Financial Statistics, L, no. 10, October, and IMF, 1999, International Financial Statistics, L II, no. 8, August. Table 1.2 Foreign exchange reserves of China Year

SDRs (millions)*

SDRs per US dollar (end of period)

US $ (billions)

1991

29,826

0.69909

42.7

1992

14,140

0.72727

19.4

1993

15,434

0.72804

21.2

1994

35,360

0.685

51.6

1995

49,498

0.67273

73.6

1996

73,040

0.69543

105.0

1997

103,680

0.74115

139.9

1998—II

105,524

0.75101

140.5

1998—III

102,899

0.72922

141.1

1998—IV

102,952

0.71021

145.0

1999—February

107,293

0.7323

146.5

1999—March

107,984

0.73646

146.6

1999—April

108,542

0.74007

146.6

1999—May

109,117

0.74358

146.7

Source: IMF, 1999, International Financial Statistics, LII, no. 8, August. *SDRs, Special Drawing Rights.

Page

Page 4 Table 1.3. Foreign exchange reserves of Brazil Year

SDRs (millions)

SDRs per US dollar (end of period)

US $ (billions)

1991

5,607

0.69909

8.0

1992

16,378

0.72727

22.5

1993

22,279

0.72804

30.6

1994

25,392

0.685

37.1

1995

33,439

0.67273

49.7

1996

40,559

0.69543

58.3

1997

37,670

0.74115

50.8

1998—II

52,281

0.75101

69.6

1998—III

32,013

0.72922

43.9

1998—IV

30,239

0.71021

42.6

1999—February

24,623

0.7323

33.6

1999—March

23,492

0.73646

31.9

1999—April

13,426

0.74007

42.5

Source: IMF 1997, International Financial Statistic, L, no. 10, IMF, 1999, International Financial Statistics LII, no. 8, August.

Table 1.4. Foreign exchange reserves of Asia Year

SDRs

SDRs per US dollar

US $

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Through accumulation of vast reserves these central banks feel that they can protect their exchange rate against a sudden ''run" on their currencies and thereby avoid the turbulence and undesirable effects of heavy speculative attacks. The build-up of foreign exchange reserves by these countries has other implications. For example, the accumulation of reserves must have provided strong support for the dollar over the period 1998/99, particularly in the first six months of 1999. Central banks were certainly not building up their reserves in euros,* but they could switch at any time. The official reserves of Brazil are shown in Fig. 1.4 and Table 1.3. The case of Brazil is an interesting one. The financial crisis that hit that country (during the first quarter of 1998) occurred somewhat later than those of the South-East Asian countries. After a sharp drop in its reserves during the crisis caused by a run on its currency, the country attempted to raise its reserves, as can be seen from Fig. 1.4 and Table 1.3. Table 1.4 depicts the foreign exchange reserves of Asia in both SDRs and US dollars over the period 1991–99. Fig. 1.5 provides a diagramatic exposition of the growth of foreign reserves in Asia during the 1990s. 1.1— Reserves Accumulation and Its Implication For some time prior to the recent bout of foreign reserves accumulation there have been various discussions that have left a question mark hanging over the excessiveness of the reserves held by some central banks; the extent of these reserves is shown in Fig. 1.1. The issue of excessive reserves in the context of this study concerns two categories of central banks: · those central banks that have already accumulated excessive reserves and which have held these reserves for some time, eg, a country such as Hong Kong or various central banks in Europe, in particular the 11 member countries that have formed the European System of Central Banks (ESCB); · those central banks that have historically held low volumes of reserves and which only ventured into substantial accumulation of foreign exchange reserves after the crises that started in 1997, eg, the Bank of Korea and some of the other South-East Asian central banks. Clearly, those countries that have been increasing their foreign exchange reserves during 1998/99 have concluded that the size of the foreign exchange reserves can lead to a rise in "creditworthiness" in the arena of the global capital market, and can magnify their ability to generate liquidity and thereby defend their currencies. Under the circumstances, two principal issues have to be addressed: · the implication of these reserve build-ups for the major "reserve currencies" such as the dollar, the yen and the euro; · the extent of information the so-called "non-transparent" monetary authorities are in practice divulging. They may publish a "benchmark" (which portrays the "intended" or "ideal" composition of their portfolio of foreign reserves). However, there can be a vast difference between the announced benchmark and the actual composition of reserves on a day-to-day basis. In other words, what is published by the central bank as its "benchmark"—specifying the weights given to different currencies within the portfolio of foreign reserve assets—can *W.

J. McDonough, 1998, "US Perspective on the Dollar and the Future Euro", Economic and Financial Review, 5, no. 3, Autumn, p. 111.

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deviate substantially from the actual weights given on different dates throughout the year for which the benchmark is published. The extent of the deviations from the announced benchmark and the actual weights is an area that is highly under-researched and about which very little published information is available. Some central bankers maintain that the market can detect the extent of the deviation of a central bank from the announced benchmark by making a close scrutiny of some of the central bank's operations, eg, paying attention to interest yields and spreads. Others maintain this is not a real possibility in practice. Historically, there has been a recommendation on the part of the IMF that an advisable ratio for determining the size of the reserves is "three months' worth of imports". This ratio was allowed to rise depending on changes in the trade balance. For the Euroland area this ratio stood at 4.3. That is, the aggregate reserves held by the member countries have been worth approximately 4.3 months of imports (Table 1.5). One may ask what are the learning lessons that would limit the destabilising effects of the next crisis on the international financial architecture. Phrased differently, the experience of the past few decades indicates that in practice each financial meltdown has yielded few lessons for the next one. This could be partly due to the dissimilarities in the roots of the crises. Nevertheless, the question remains as to whether many of the anxieties of central bankers, reserve managers or policy makers vis-à-vis foreign exchange stability and management would disappear if the world economy were to adopt a single currency.* Is this the inevitable direction in which the world should go? Table 1.5. Size of foreign exchange reserves relative to countries' imports Country

Months of countries' imports

US

less than 1 month of imports

France

just over 1 month

UK

between 1 and 2 months

Canada

between 1 and 2 months

Netherlands

between 1 and 2 months

Germany

between 1 and 2 months

Sweden

just under 2 months

Austria

between 2 and 3 months

Australia

between 2 and 3 months

Italy

between 2 and 3 months

New Zealand

just under 3 months

Finland*

just over 3 months

Denmark

between 3 and 4 months

Spain

over 5 months

Japan

over 5 months

Norway

just over 5 months

China **

over 11 months*

Source: Central Bank of Norway, 1998, Economic Bulletin, p. 246, and People's Bank of China,1999, Annual Report 1998, p. 16. * See also A. Alho, 1996, "Finland on the Way to the EMU", Economic and Financial Review, 3, no. 1, Spring, p. 13. ** For China the data were calculated by the European Economics and Financial Centre for the purpose of this study. The calculation behind the derivation of the months of imports for China was as follows: the total amount of imports for the first 6 months of the year 1999 (until the end of June) was US$75 billion. The average monthly size of mport was arrived at roughly as US$12.5 billion per month. Accordingly, the size of reserves as a multiple of imports was estimated as equivalent to 11.76 months of imports (ie, derived as 147 ÷ 12.5 = 11.76 months of imports). The basic data were provided by the People's Bank of China.

*See

also J. Dehaene, 1998, "Management of Economic Policies in the Eurozone", Economic and Financial Review, 5, no. 4, Winter, p. 157.

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With respect to reserves build-ups, two questions arise. · Does a higher level of reserves make a country more immune to massive speculative attacks? Was Hong Kong able to maintain its peg to the US dollar because of its high level of reserves (around US$90 billion)? · Is maintaining the value of a currency and that of, say, a peg (as was the case in Hong Kong), preferable to a depreciation of a currency (which was the case in Korea)? A massive depreciation of the Korean won, of some 60%, was caused by the crisis. The massive depreciation of the Korean won caused the trade balance of Korea to go quickly into surplus, ie in the following year. The trade balance showed a net surplus for the year 1998. By contrast, the Hong Kong economy was adversely affected by the crisis and subsequently experienced a drop in its exports. Following the crises, exports in Hong Kong weakened and unemployment rose. Perhaps if the value of the Hong Kong dollar against the US dollar had been lower, a higher level of exports could have been achieved, which would have stimulated the economy somewhat more quickly. Foreign exchange reserves can rise as the result of three factors: · trade surplus; · foreign direct investments (FDRs); · borrowing, etc to build up its reserves. Chapter 3 provides an extensive discussion of motives for holding reserves. Table 1.6 portrays the size of the foreign exchange reserves of selected countries. Details of all the countries' reserves are presented in Appendix A. 1.2— Autonomy of Central Banks Broadly speaking, whereas commercial banks are answerable to shareholders, central banks are indirectly answerable to the general public. However, the extent to which central banks are answerable to the public depends upon the extent of independence the central bank enjoys. In a society where governments are democratically elected the public exerts influence via the parliament. Even when central banks have been granted full independence with respect to their conduct and operations, the appointment of the governing body of the bank has to be approved by the parliament. Moreover, certain committees of a parliament can periodically (or regularly, as is the case of the US) ask the governor of a central bank to answer the questions that the members of the committee may have. In this respect it can be said that central banks are indirectly answerable to the public. The autonomy of central banks is discussed in Chapter 2. 1.3— Transparency of Central Banks Transparency is an issue that is much discussed and hotly debated in some circles. On this question some monetary authorities argue that it would only be meaningful for some central banks to be transparent if commercial banks and investment banks are transparent too (ie, if the counterparties to central bankers were equally open about their tactics and operations).

Issues pertaining to transparency are seen throughout the study and are discussed in relation to different subject matters covered in this report. In practice, however, some central banks allow the world outside to learn very

Page 8 Table 1.6. Total reserves of selected countries in May 1999 as compiled by the IMF Country

SDRs (millions)

US $* (millions)

Argentina

17,379

23,372

Australia

9,835

13,227

Bahrain

936

1,259

Belgium

6,871

9,240

31,426

42,263

1,835

2,468

16,097

21,648

818

1,101

Czech Republic—March

8,745

11,761

Denmark—1998 IV

9,767

13,135

Estonia

472

635

Finland

4,331

5,825

Germany

37,709

50,713

Hong Kong

66,085

88,874

6,296

8,467

299

402

22,765

30,615

3,403

4,576

Italy

12,367

16,632

Japan

157,747

212,145

Korea

45,397

61,052

Kuwait

2,834

3,812

Lebanon

4,744

6,380

Malaysia

20,933

28,152

Mauritius

420

565

2,745

3,692

54,020

72,649

3,167

4,259

25,302

34,027

9,177

12,342

Switzerland

24,143

32,469

Thailand

22,016

29,608

Turkey

16,190

21,773

Brazil—April Bulganria Canada Cyprus—March

Hungary Iceland India Ireland

New Zealand Singapore South Africa Spain Sweden

UK—April

17,563

23,620

US

22,009

29,599

Source: IMF, 1999, International Financial Statistics, LII, no. 8, August. *SDRs conversion rate: 0.74358 = 1 US$ for May 1999.

little about how their organisation behaves in relation to the conduct of its operations and prices. Some, on the other hand, are more open and publish detailed information in their annual reports. 1.4— Responsibility for the Management of Official Reserves Whose responsibility is the management of foreign exchange? Who holds reserves? In some countries only the central bank holds the foreign exchange reserves. In other countries, such as the US and Japan, official reserves are partly held by the central bank and partly by the Ministry of Finance (in the case of US and the UK called the Treasury). However, even the distribution of reserves within these countries is different. For example, in Japan out of a total of about US$200 billion, about US$25 billion is held by the central bank and about US$175 billion is held by the Ministry of Finance. However, in the US out of total reserves of around US$30 billion, some US$16 billion is held by the Federal Reserve Board of New York and the rest is held by the US Treasury. 1.5— Gold It is worth noting that this study concentrates primarily on the foreign exchange reserves of countries, analysing all the ramifications and implica-

Page 9

tions. The focus of the report is not on gold and the topic is excluded from the discussion as gold (being a commodity) is considered an asset in a separate category. Perhaps this could be the subject of a different study. Although historically gold has been a component of global monetary reserves, its role has been diminishing over time. Suffice it to say that during the 1990s governments have been selling gold and attempting to reduce their holdings of this asset. For example, in 1999 the UK Treasury announced that it intended to dispose of over half of its gold reserves: out of a total of 715 tonnes, the UK Treasury planned to sell some 415 tonnes. This caused turmoil in the gold market and subsequently, in September 1999, 15 central banks announced a moratorium on the sale of their gold for a period of 5 years, aimed at restoring some element of stability in the market. In addition the IMF cancelled its plans for an open gold sale in order to restore stability in the market. Despite this moratorium, Switzerland and the UK were allowed to continue the disposal of their gold sales with the proviso that within a given year the sales would not be in excess of 400 tonnes with a ceiling of 2000 tonnes for the 5-year duration of the moratorium. 1.6— Aims and Objective of this Study The focus of this report is in effect on "reserve policies" globally, for it covers a range of issues pertaining to the foreign exchange holdings of different countries. Chapter 2 aims to provide the reader with a basic understanding of central bank balance sheets. Chapter 3 then discusses the prime motives for holding reserves, while Chapter 4 analyses the criteria for forming and selecting the composition of reserves. That is, once the size is determined then the composition question arises and, accordingly, attention is paid to the relevant considerations. Benchmarks and their uses are examined in Chapter 5. Chapter 6 looks at linking of a country's exchange rate to a currency basket and Chapter 7 outlines the options for a central bank. This book also addresses the issue of reserve management from two perspectives: · from the perspective of those operating within the economic monetary union (EMU) zone to include the European System of Central Banks (Chapter 8); · from the perspective of the non-EMU region (Chapter 9). The final chapter (Chapter 10) focuses on limiting the destabilising effects of the international financial architecture and advances the notion of a global single currency. Currency fluctuation is a destabilising factor on the performance of the real sector. For a country the advantages of having its "own" currency are similar to those of "gambling" as an activity. Whereas occasionally one can win, most of the time the players tend to lose—for otherwise gambling casinos could not survive and continue to thrive. In the same manner, whereas countries may occasionally gain from their currency fluctuation (say, as a result of a currency depreciation or an outright devaluation), most of the time the pains and adverse movements of currency fluctuations bring far greater costs than benefits. Chapter 10 suggests that the development of a global single currency will go hand in hand with the development of e-commerce. Competition will be so severe that the world of commerce will need to price its goods and services in a currency that brings business.

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2— Understanding Central Bank Balance Sheets This chapter (combined with Appendix B) aims to provide a basic understanding of some of the intricacies of central bank balance sheets, conventions, terminologies and some of the terms applied by these organisations.* The chapter brings to the fore the substantial variations that exist among central banks. It also highlights the features that distinguish of the role of the central banks from those of ministries of finance/treasuries with respect to official foreign reserves. At the very outset it should be pointed out that this chapter was compiled because in the course of this research it became increasingly apparent how difficult it was to decipher meaningful information on international reserves. In fact, as more official documents were examined, two questions arose: · What do different governments label exactly as foreign reserves? and · Where should one look for them? The first question is: How does one obtain accurate data on official reserves of a given country in the first place? The standard answer should be in the balance sheet of the central bank of the country concerned. However, this turned out to be quite a minefield, since there is no uniformity among central banks in the manner in which their balance sheets are presented. There are several reasons for this lack of homogeneity in the layout of central banks' balance sheets. · One reason is their historical background. Ideas about central banks and their role in the economy have gone through various phases in the past decades, especially after the abandonment of the gold standard system. The constitution of most central banks has changed during the 1990s and they have developed into modern institutions with a distinctive monetary policy function. However, the pace at which these changes have occurred has been different from country to country and, for some economies, this process has just started. · A second explanation for the heterogeneity across central banks statistics is related to banking competition, a by-product of the process of globalisation, liberalisation and deregulation of the financial markets since the 1980s. The competition has prompted banks, including central banks, to introduce and use a number of innovations, such as swaps, options, securitised paper and offbalance sheet obligations, for which the regulatory framework is by no means clear. Banks use different criteria to disclose data on these financial instruments. · A third reason is related to the periodic financial crises that have hit countries around the world. Financial innovations and deregulation have produced greater volatility of prices, interest rates and exchange rates. As a consequence of the increased volatility of economic and financial variables, the asset side of banking systems around the world has become more and more vulnerable to shocks. *See

also H. M. Scobie, 1994, The European Single Market Monetary and Fiscal Policy Harmonization, London, Chapman & Hall.

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Economies in different corners of the world have experienced periodic financial disruptions. Financial crises have hit both the developed economies with advanced financial systems and reasonably strong supervision, as well as the smaller, open-market oriented developing economies that have suffered shocks, bank fraud or mismanagement. Again, financial disruptions have hit both the centrally planned economies with nationalised banking systems, as well as the hyperinflation economies that are still undergoing various stages of financial and structural adjustment. In dealing with financial crises, each central bank had to work with different resources and financial and regulatory constraints under diverse cultural, political and legal environments. These different experiences have not helped to create a uniform and cohesive system of central bank statistics. Would a more uniform disclosure of banking data help in managing or possibly in preventing financial crises, and predict possible contagion effects across economies? How homogeneous and, hence, comparable should the data on financial activities be? Here a distinction should be drawn between two different groups of financial data statistics. At the international level, encouraging progress has been made under the auspices of both the Bank for International Settlements (BIS) and the International Monetary Fund (IMF) to enhance public disclosure of international statistics. Thus, at one level there is a certain degree of homogeneity of information available. In contrast, at a national level there is still a great deal of heterogeneity across countries in the way financial data, and specifically central bank data, are disclosed to the public. Indeed, our examination of the balance sheets of central banks has shown that there is considerable variation in the layout and the composition of the balance sheets. For this reason, in Appendix B we have reproduced the latest balance sheets of over 40 central banks from different corners of the world; these countries are as follows: Argentina

Hong Kong

Mauritius

Australia

Hungary

Mexico

Austria

Iceland

Netherlands

Bahrain

India

New Zealand

Belgium

Indonesia

Philippines

Brazil

Ireland

Portugal

Bulgaria

Israel

Singapore

Canada

Italy

Slovakia

Cyprus

Japan

South Africa

Czech Republic

Korea

Spain

Denmark

Kuwait

Sweden

Estonia

Lebanon

Switzerland

Finland

Lithuania

Thailand

France

Macedonia

Turkey

Germany

Malaysia

UK

Greece

Malta

US

2.1— Conventions and Terminology If a central bank is to influence the behaviour of financial aggregates and rates of interest, one necessary condition is that its balance sheet be sufficiently large with respect to the size of the economy. The other condition is that a central bank needs to be able to manage the size and composition of its balance sheet, as regards both assets and liabilities. The first condition brings up the issue of how to interpret balance sheet convention and terminology. The second condition leads to the considera-

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tion of the role of the central bank and its independence and discretionary power in relation to the government of the country. This issue will be examined later. The two points are clearly interrelated, as the composition of the central bank's balance sheet reflects the role and the functions attributed by the country to its own central bank. Not all central banks of the world share the same statutory objectives and they are not all given the same functions. On the contrary, the range of functional differences among central banks is wide and these differences are rooted in each country's historical and cultural traditions. For example, there are some central banks that are given a large degree of independence from the government. In contrast, in other countries central banks need the approval of the government to perform some operations. As an example, one can consider the issue of controlling the external value of a country's currency. In some countries the central bank is the guardian and defender of the domestic money, with the discretionary power to intervene and choose the strategy as well as the instruments to implement it. In other countries, the role of controlling the exchange rate is mainly attributed to the government. For instance, in the US the treasury is involved in the managing of the exchange rate and holds a considerable amount of international reserves. In general, the government's consolidated monetary account, which includes other institutions (such as the treasury) in addition to the central bank, provides an important source of information to financial analysts. Thus, at a general level, the existing diversities in central banking legislation and balance sheets could in part be explained by the different functions in policy-making undertaken by each individual central bank. The layout and composition of central banks' balance sheets vary as central banks may adopt: · different degrees of aggregation within similar categories of assets and liabilities; · uncommon items (some countries have specific assets or liabilities that are not common to other countries); · different terminology (some countries may use a different wording to refer to the same kind of item). Before drawing attention to the technical differences across central banks balance sheets, one should briefly consider the common essential elements that all central banks' balance sheets are likely to share. At first glance, the balance sheet of a central bank is similar to any other balance sheet. It has assets (financial as well as other types of assets such as buildings and equipment) on one side and liabilities on the other, with a net worth item as a residual on the liability side. However, if one looks in more detail at the entries, they can appear to be quite unusual and specific for the role that a central bank performs in creating and controlling the creation of money and liquidity in the system. The high-powered money (monetary base) is created when a central bank acquires assets in the form of international reserves (foreign exchange and gold) and central bank credit (loans, discount and government bonds). Central bank credit refers to the securities held by the central bank (such as treasury bills), loans and discounts made by the central bank (such as an overnight loan), and various other credit assets of the central bank. It is useful to have a record somewhere of how many notes are in circulation and what they were used to buy. This is the reason why analysts scrutinise central banks' balance sheets. They are not so much worried that a

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central bank is going bankrupt, but rather they want to learn about the central bank's financial transactions, in order to understand and anticipate financial market conditions. 2.1.1— Overview of a Central Bank's Assets A central bank's assets can be identified in two large categories, such as international versus domestic assets (the former are defined by some central banks as "external assets"). The international assets are usually broken down into the following categories: · gold; · foreign currency (convertible as well as non-convertible); · other net foreign assets. For IMF members, the balance sheet reports the total amount of the following additional items: · special drawing rights (SDRs); and · participation in the IMF. The first two items, gold and foreign currency, are self-explanatory. The net foreign assets refer to foreign assets net of the central bank's liabilities to foreign central banks. The latter are usually differentiated in the form of foreign official deposits held at the domestic central bank. Generally these deposits constitute a relatively minor item on the central bank's balance sheet. In the Federal Reserve Board's balance sheet, gold reserves are actually defined as gold certificates. In fact, the treasury issues gold certificates to the Fed when the treasury acquires gold. The treasury writes a cheque drawn on its Fed account (which is part of the Fed liabilities not analysed yet) to pay for a few specks of gold dust, and the seller brings this cheque to the local Federal Reserve Bank for redemption in real money. The treasury issues a gold certificate to the Fed and is credited for the equivalent. The net effect is that the treasury has more gold, the Fed has the equivalent in gold certificate, and the monetary base has changed. The Fed does not instigate this change of monetary base. The other item of the international reserves, namely the SDRs, is relatively recent (it was instituted in 1969) and is a hybrid kind of international asset. The SDRs are assets similar to gold certificates, except that they are "paper gold" used in international finance, and only among members of the IMF. The historical and technical aspects of SDRs are described in Chapter 6. Among the domestic assets, it is quite common to find the following items: · cash; · bank loans; and · securities purchased by the central bank. The first item of domestic assets seems quite confusing. Some countries use a different terminology and refer to this item as "treasury currency", which is to some extent a less confusing term. In fact, some money outstanding in the system is not issued by the central bank, but by the treasury. For example, there are a fixed 0.3 billion dollars in US treasury notes outstanding, which trace back to

the old Civil War greenbacks. In some countries the treasury is responsible for the creation of coins (Italy, for instance).

Page 15

The other important domestic asset is constituted by bank loans. These are banks' borrowings from the central bank, usually through its discount window. When a bank borrows from the central bank, bank reserves and the monetary base are increased (another example of the creation of money outside the direct action of the central bank). The other category of domestic assets is constituted by those securities purchased by the central bank. Such transactions are called "open-market" operations. To the extent that various financial assets are good substitutes, open-market operations are broadly based policy instruments with dispersed effects throughout the financial markets. In the last 20 years some central banks have engaged in temporary security repurchase (so-called repos). Commercial banks borrow money from firms using repos to avoid rate ceilings and reserve requirements. With a repurchase operation, the central bank buys or sells securities to a private dealer, who agrees to sell or buy them back at a certain price on a certain date, usually within a week or two. Thus, securities are collateral for a short-term loan. Central banks use repos to cause an explicitly temporary expansion or contraction of the monetary base. The relative size of the figures gives some kind of tentative explanation of the conduct of monetary policy and of the role and objective of the central bank. For some central banks, such as the Bank of Italy and the US Federal Reserve System, the financing of the treasury has represented a quite large item of the asset side. In other cases (Germany and France), the refinancing of the private financial system instead of the public sector has represented a high figure in the balance sheet. These facts show that in Italy and the US influence on market conditions has been mostly transmitted via open-market operations and financing of the public debt. In Germany and France, there has traditionally been more direct influence on the financial system via lending directly to the banking system and the supply of liquidity to the private financial sector. The creation of the European Central Bank and the Growth and Stability Pact are going to affect heavily the relative weights within assets and liabilities of central banks of the EMU area. The relative weight of domestic versus international assets is also an indication of the role of the central bank in controlling the external value of the domestic currency. Some central banks do not hold reserves but only manage them, such as the Bank of England. In some other countries, such as in Canada and the US, the central bank holds only a percentage of the total international reserves; the rest is held by the treasury or by other government authorities. The extent of the holding and management of reserves is a function of the type of exchange rate regime adopted by the country. By looking at the different balance sheets presented in Appendix B it is easy to see that—among the non-EMU economies—there are countries that have a very high level of reserves relative to the total of their assets. Thus, for these countries the management of reserves cannot be seen as a residual activity. Examples of such countries are: · Singapore (99%, ie, the international assets represent roughly 99% of the total assets of the Singaporean central bank); · Estonia (96%); · Lebanon (86%); · Hong Kong (74%); and · Switzerland (73%).

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For other countries, the weight of the international assets relative to total assets is quite low. Examples of central banks at this other extreme of the spectrum are as follows: · Bank of England (0%); · US Federal Reserve Bank of New York (5%) · Bank of Japan (6%); and · Bank of Canada (8%). 2.1.2— Overview of a Central Bank's Liabilities The usual items of this side of the balance sheet are as follows: · foreign liabilities; · domestic liabilities, of which: · notes; · banks' reserves; · treasury deposits; · net worth items. Some of the liabilities of a central bank are quite special, as they represent the money or monetary base of the system. Because of their intrinsic qualities, legislative prescriptions and long traditions, these liabilities have the features of absolute liquidity and general acceptability, and serve as means of payments. The notes issued by a central bank represent the bulk of the liability side in the balance sheet. These notes are used to buy assets or pay debts. A small amount of notes are held by the treasury, some are kept in bank vaults, and the public holds the bulk of notes. To confuse matters, some treasury currency is held by the central bank (the so called ''cash" in the asset side of the balance sheet), and the treasury holds some of the central banks notes. These holdings, although in general small, complicate any calculation of the amount of money in private hands. In addition to the notes, an important liability in computing a country's monetary base is represented by the reserves deposited by domestic banks with the central bank. These are used for inter-bank transfers within the central bank and help to create liquidity for the financial system. Analysts are often interested in the bank reserve part of the monetary base, since banks' deposits are a major part of various monetary aggregates such as M1 and M2. In many cases these banks' reserves are compulsory, and are referred to as "reserve requirement". The reserve requirement strengthens the link between the size of the central bank balance sheet and that of the consolidated balance sheet of the banking system. Some countries do not have, or have abolished, reserve requirements (New Zealand, say, in 1985). In the UK and the Netherlands the central banks have been able to vary the reserve requirements, if

they wished to, by making recommendations to bankers; but if agreement could not be reached with the bankers, government approval would be required before legally binding directives could be issued. In France, a change in reserve requirements needed to be approved by the government, through the National Credit Council. In Germany, the US and Chile, the central banks have been able to vary reserve requirements: the Fed has not actively varied requirements in the past, but the Bundesbank has.

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Another common liability to many central banks' balance sheets is treasury deposits. The treasury usually deposits money with the central bank and then pays its bills by writing cheques against these deposits. In the US, for instance, the treasury actually has deposits (called "tax and loan accounts") in commercial banks throughout the country. But it does not use these deposits for paying bills. The treasury withdraws from these accounts periodically. The withdrawals occur by transferring the commercial bank's reserve account with the Fed to the treasury's account at the Fed. The treasury then pays the government's bills by writing cheques drawn on its Federal Reserve account. Another type of liability specific to the US Fed is related to the asset categorised as "cash in process of collection". The cash items in the process of collection are cheques that the Fed has not yet delivered and subtracted from bank reserves. On the asset side there is a corresponding item that is defined as "deferred availability cash items". Deferred availability cash items are cheques that the Fed has received but not yet credited as bank reserves. The difference between these two categories represents the Fed Reserve float. From looking at the central banks' balance sheets, one observation comes naturally: there is not a single central bank that diffuses, through its balance sheet, the composition of the international reserves and the international position vis-à-vis the rest of the world. However, it is possible for the US to have access to a more comprehensive presentation of their assets and liabilities compared with the rest of the world. The Department of Commerce issues the International Investment Position (IIP) of the US for selected years, to depict the country's international investment position. The IIP shows the composition of the stock external assets and liabilities accumulated by the country's residents up to a certain date. The table is computed by the Bureau of Economic Analysis (BEA) of the US Department of Commerce, which publishes its estimates in the Survey of Current Business. The US official reserves are included, of course, among the assets. 2.2— Definitions of Terms Used by Different Central Banks Although there are some common terms in central banking language to identify categories of assets and liabilities, some items in the balance sheet are specific to particular countries. For instance, the Australian central bank has among its liabilities, deposits and "profit distribution payable to the Commonwealth of Australia". Another example is the word "Fines" used by the Central Bank of Brazil. Many other examples of countries that use uncommon and unusual terminology on their balance sheets can be seen in Appendix B. 2.3— Variation between Central Banks Apart from those differences that are attributable to country-specific items, the variations across balance sheets can broadly be grouped into the following categories: · those due to a different level of aggregation of data, and differences in layout; and · those created by the use of different terms to indicate conceptually equivalent items. As regards the first group, among the less detailed balance sheets one can assemble the following central banks:

Page 18

· Bank of Bahrain; · Bank of Thailand; · Central Bank of Hong Kong (Exchange Fund); · Bank of Singapore; and · Bank of Lebanon. Among the most detailed balance sheets, one can include the following: · Bank of Brazil; · Bank of Sweden; and · Bank of Turkey. Clearly the degree of transparency is a function of the degree of aggregation of data. For instance, some balance sheets have gold and foreign exchange together on one line (Singapore, Mauritius, Malaysia). Some countries, such as Turkey, Japan, New Zealand, and South Africa aggregate all "Government securities" on their balance sheets, whereas for some other countries, for instance Argentina, government securities are broken down into national treasury consolidated bond, bills issued in relation to IFM loans and "Others". Other countries such as Bulgaria and Korea merely have "Securities" on their balance sheet. Countries including Australia, Belgium, Brazil, Denmark, Germany, Hong Kong, Hungary, India, Ireland and Singapore do not seem to include any government securities whatsoever. Some countries, for example Sweden and the UK, have just "Treasury bills" and "Eligible bills". The Iceland heading is "Centre government''—which includes treasury accounts, marketable securities and treasury bills. Some countries distinguish between long-term and short-term loans. In some cases (for instance the UK and the US), loans are aggregated, while in many other instances, loans are separated into three categories: private, government and commercial banks sector. Participation with IMF is sometimes detailed (Belgium) or separated (Germany, Finland) or mentioned in association with some other account (Denmark). As regards the layout, the Brazilian balance sheet has more components in its asset side than any of the other balance sheets. The variables on the Brazilian balance sheet are broken down into "Foreign", "Internal", "Permanent", "Investments" and "Immobilised". The balance sheet of Argentina is quite clear and straightforward whereas that of India is quite extensive. The Bahrain balance sheet is horizontal in shape, with assets and liabilities going from left to right. The asset side comprises five columns with "Foreign assets" taking up two columns, namely "Gold" and "Foreign exchange"—while the liabilities side has eight columns. The way in which the data are presented is analysed in Table 2. 1. Finally, part of the variation among balance sheets is more attributable to the use of different terms to indicate conceptually identical items. For instance, in some balance sheets the term "advice" is used instead of the term "loans" (eg, New Zealand, Mauritius and Canada). In some other balance sheets a third option is adopted: the term "loans" is replaced with the term "Claims on financial" in IMF/public sector (eg, Finland, Denmark, Bahrain and Thailand). Sometimes "bullion" is used

instead of "gold", and "coins" instead of "cash".

Page 19 Table 2.1. Presentation of data in the balance sheet Examples of balance sheets where data are presented in vertical form

Examples of balance sheets where data are presented in horizontal form

Argentina Australia Bahrain Brazil Belgium Bulgaria Canada Czech Republic Cyprus Denmark England Estonia Finland Germany Hong Kong Hungary Iceland India Ireland Italy Japan Korea Lebanon Malaysia Mauritius New Zealand Singapore South Africa Switzerland Turkey Thailand US

2.4—

Central Bank Functions Versus Ministry of Finance Functions As far as the issue of official reserves and its management is concerned, the question arises as to what features distinguish the role of central banks from those of ministries of finance. What are the links? Whose responsibility is it to manage the currency? If a currency appreciates too much (as has been the case of Japan during 1999), is it the decision of the ministry of finance or the central bank to intervene (and sell the yen in the case of Japan)—so that it prevents the appreciation of the currency? The country can also print a certain quantity of the currency (say, of the yen in this example) in order to prevent an appreciation of the currency. These issues relate to a country's priorities, which have to be spelled out and ranked, such as: · exchange rate stability; and · return on assets (or national savings). Different countries follow different policies with setting responsibilities for the ministry of finance (called the treasury in some countries) versus the central bank. In some instances it is the decision of the ministry of finance to intervene in the foreign exchange market in order to sell or buy the foreign currency with the intention of reversing an unwanted appreciation or depreciation. Japan offers an example of such a country. It has over US$200 billion of official reserves, of which the central bank holds around US$25 billion of

Page 20

foreign reserves. The rest is under the control of the ministry of finance. However, the reserves are managed by the central bank, on behalf of the ministry of finance. Thus, the decisions to intervene are taken by the ministry of finance in Japan and the operation of it is carried out by the central bank. As a rule, the ministry of finance representing the state has the task of taking care of the fiscal shortfall of the state and financing as well as balancing the budget. It is argued that a ruling government should not have access to assets that are held externally and are very liquid. Instead the central bank should be charged with the duty of taking care of the country's assets that are held outside the country and are liquid. In relation to reserve management the issue of external debt is also relevant in as much as the country may wish to use its reserves to repay its debt ahead of the schedule. During the 1970s and 1980s important changes were also made in the way a number of countries conducted their monetary policy. The major reason for such changes appears to have been the recognition of the value of monetary policy "credibility" and transparency for achieving policy objectives more effectively and more efficiently. To this end, some countries have substantially changed their central banking legislation, so as to grant central banks a greater degree of monetary policy autonomy. For instance, at the beginning of the 1980s Italy decided to resort to the so-called divorzio (divorce) between the Bank of Italy and the treasury. More recently in the UK, the Labour Government has introduced reforms to allow independence for the Bank of England. Such tendencies naturally raise a fundamental question about the appropriate role performed by central banks. In particular, what functions should a central bank undertake and what type of relationship should be envisaged between central banks and governments? These issues will be addressed in the following section of the chapter. 2.4.1— The Role of a Central Bank Typically a central bank is given the exclusive authority to determine the quantity of money in circulation. It also exercises authority over other types of money, such as demand deposits, that represent liabilities of other financial institutions. The most common policy functions carried out by a central bank can be broadly divided into two categories: those involved directly with monetary policy operations and those of other associated functions. Functions most closely related to the conduct of monetary policy include: · management of currency issues; · banker's bank; and · government's bank. Other functions include: · supervision of financial institutions and markets; · lender of last resort, carrying out exchange rate policy, including foreign exchange market management and control; · holding and management of international reserves;

· fiscal agent and management of public debt deposit insurance; and · participation in clearing and settlements.

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In the first group of functions, the currency issues and the banker's role are fundamental to central banking and are viewed as the very core of monetary policy. In many countries the role of government banker has also been close to the core of monetary policy, although it seems clear that this is not essential. The functions in the second group are not so closely related to monetary policy, but they nevertheless exert some kind of influence on it. For the purpose of this study, the interaction between monetary policy and reserve policy is a particularly relevant issue; this is analysed in Chapter 7. A very common and delicate question to ask is the following: In carrying out its functions, to what degree can a central bank act independently from other public institutions? A central bank can be endowed with monetary policy independence in the full sense when it is insulated from political pressure and has considerable discretion in the determination and conduct of monetary policy. There are numerous types of situations that range between complete discretion and completely binding rules, as for example when the bank is committed to certain monetary targets (i.e., inflation targets), and when it is committed to monitor and peg the exchange rate. In discussing the issue of central bank independence, different aspects should be distinguished. The two most important aspects can be identified in the institutional and in the functional independence assigned to the central bank. The first, the institutional or formal independence aspect, is linked to the delegated authority attributed by law to the bank. Given the first level of independence, the second aspect concerns the types of detailed arrangement envisaged so as to make the bank functionally independent. 2.4.2— Formal Independence Under this aspect varying degrees of independence for the central bank are possible.* At one extreme one can find central banks that have a great deal of formal independence. The three most formally independent central banks (ie, those of Germany, Switzerland and the US) were established in federal systems, where a wish to constrain the powers of the national government has played a central role in political history. For instance the Deutsche Bundesbank has the statutory responsibility to determine monetary policy, but also the obligation to support the general economic policy of the government to the extent that this is in line with the Bank's statutory objectives. The Swiss National Bank is constitutionally independent from the political authorities, but the bank and the government are obliged to consult each other before implementing policies. At the other extreme, such formal independence is denied in the legislation of some other central banks. In France, the Ministry of the Economy decides the stance of monetary policy. In the UK, HM Treasury (the equivalent of the US Treasury) has the power (unused so far) to issue formal but unpublished directives to the bank. In practice, the treasury is in control of the official reserves, and the Bank of England is the agent that implements monetary policy in consultation with HM Treasury. On 6 May 1997 the UK Chancellor of the Exchequer declared that the Bank of England would retain its responsibility of setting short-term interest rates, but that it would transfer the responsibilities of managing the government debt, cash and the sale of gilts to the treasury. This decision was aimed at enhancing transparency in the country's debt and cash management *See

also J. L. Malo de Molina, 1995, "The Role of Central Bank Independence: A Point of View from the Spanish Experience", Economic and Financial Review, 2, no. 1, Spring, p. 21.

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operations so as to guarantee that any debt management decisions would not be influenced by inside information on interest rate decisions. Following the above decision the responsibility for managing government debt, the cash needs of the exchequer and the operations in the gilts market were assigned to a new executive agency of the treasury—entitled the Debt Management Office (DMO). The DMO was established at the beginning of April 1998 with the explicit objective of carrying out debt management operations in line with the treasury's goal of minimizing the financing cost of the government's borrowing while taking into account risk factors. The policy objectives of the DMO ought to be compatible with objectives of monetary policy and that of gilt sales. If the DMO wished to use debt management for other macroeconomic objectives, for example to reinforce exchange rate credibility or to achieve some money supply targets, then the implementation of these policies would require that the treasury minister changed, through a public statement, the DMO's objectives. Between the above two extremes is the US Federal Reserve System, which is explicitly independent of the executive branch of the government in determining and implementing monetary policy, but it must report twice a year to the Congress. In practice, the Fed is continuously in contact with all policymaking bodies of the government. In the Netherlands, the government has had the right to issue formal directives to the Netherlandsche Bank. In Chile the central bank has the authority to design and implement monetary policy, but it is required to take into account the general direction of government policies. In New Zealand the central bank has the responsibility of formulating and operating monetary policy to achieve the bank's statutory objective of price stability. However, the conduct of monetary policy ought to be in line with published policy targets agreed between the bank's governor and the Minister of Finance. Among the important facets of formal monetary policy independence is the extent of legal constraints on a central bank's funding of the government. Chile has one of the tightest legal restrictions: no public expenditure may be financed directly or indirectly by the central bank credit (except during wartime), and the central bank cannot purchase paper issue by the government or by its agencies. The legislation of Germany, Switzerland and the Netherlands sets strict limits on the direct credit of the central bank to government, although the bank can purchase government securities to conduct open market operations. In the US and the UK there are no specific legal limits. In France limits are agreed upon between the Bank of France and the treasury and need to be approved by the Parliament. In other words each country has devised its own system of checks and balances so as to harmonise discretion and hold control over the delicate issue of monetary policy. 2.4.3— Practical (Functional) Independence A central bank is effectively empowered with discretionary power when a legal independence corresponds to a practical independence, ie, when the bank can manipulate the instruments of monetary policy without needing the approval of the government. As a general rule, central banks that have little policy independence tend to have statutory objectives that are either more broadly defined (like those of the Bank of England) or that are defined in terms of functions rather than goals. In contrast, banks with greater formal independence tend to have statutory objectives that are more specific and with a narrower focus, like stability in the domestic or external value of the currency (Germany, Netherlands, New Zealand and Chile).

Page 23

At a broader level, the practical independence of monetary policy depends on the nature of the exchange rate regime chosen by the country. The more the exchange rate is managed, the less freedom there is to choose a monetary policy that differs from the one prevailing at the international level. Chapter 6 presents several options for exchange rate arrangements currently used by countries across the world. In most countries the central bank holds and manages official reserves with little (if any) interference from the ministry of finance. Some exceptions are those represented by the following cases: · In the UK HM Treasury owns the reserves but the Bank of England manages them. · In the US and in New Zealand, the treasury and the central bank both hold reserves. Central banks can use these reserves for exchange market intervention on behalf of their governments, and in some cases can also operate in the foreign exchange markets for their own purposes. In particular, the US Treasury has an "Exchange Stabilisation Fund", which implies that the treasury has the objective to stabilise the dollar. In US legislation the view has been taken that, as the state is charged with the task of repayment of the debt, it should also have the possibility of selecting in which currency (or currencies) the external debt is raised and what maturity the external debt should have. In other words, the state should have active participation in external debt management, in the choice for selecting the combination of the currencies in which the foreign debts are raised, as well as the repayment length of the loans. Some countries have a specific office for debt management (eg, Portugal and New Zealand). The central banks of Germany and Chile have had a major role in external debt management. In some instances, central banks have expanded their role to become true intermediaries for foreign resources by borrowing abroad and advancing them to the government at low interest rates. In Argentina, the foreign assets of the central bank have been sold to the Government in exchange for a government security denominated in foreign currency. Technically, this kind of operation does not directly affect the central bank balance sheet. However, it affects the profits of the bank, if, as in the Argentinean case, the government assets are non-earning assets. Thus, a certain degree of independence from political pressures and government fiscal needs, as well as a certain level of discretionary power in reserve management, are seen as conditions for a successful and profitable central banking activity. 2.5— Disclosure of Financial Data at the International Level: Common Standards While at a national level each central bank follows its internal rules and legal dispositions to disclose data on its activities, at the international level there are, to some extent, common standards and rules adopted by some countries to enhance transparency in diffusing international financial statistics. The collection of the BIS data in the field of international financial statistics started in 1983 with semi-annual reports on international banking. Since then, much progress has been made in terms of timeliness and area of reporting activities. The BIS data now cover international securities and derivatives. The experience of the Asian crisis has created a more acute concern about the transparency and

consistency of a central bank's data on their foreign currency activities. In particular the Governors of the Group of Ten

Page 24

(G10) have stressed the importance of a suitable diffusion of countries' international liquid position. The G10 recognised the value of information both on a country's foreign exchange resources and on the possible short-term drains on those resources. In response to this concern, the G10 governors asked the Euro-currency Standing Committee to develop an efficient scheme to release information on a country's international liquidity position. The dilemma faced by the working group was to balance the benefits of greater transparency against the potential costs of reducing the efficacy of official interventions in the exchange rate markets. The solution envisaged by the working group is reported in the document Enhancing Transparency Regarding the Authorities' Foreign Currency Liquidity Position issued in September 1998 by the BIS. The group recommended that countries' data should conform to a proposed template. The template was reviewed by a group of technical experts (December 1998). The changes are presented in the report on Review of the Disclosure Template Regarding the Authorities' Foreign Currency Liquidity Position, published by the BIS. The new template format, attached to the report, incorporates the proposals under discussion at the IMF. In fact, in the effort to improve the quality of statistical information of the international reserve data, the IMF Executive Board had moved in the direction of strengthening the Special Data Dissemination Standard (SDDS). The SDDS is a scheme that provides guidelines and rules for diffusing economic and financial data. Members of the IMF abide to these standards only on a voluntary basis. As of March 1999, as many as 47 countries had subscribed to the SDDS. The IMF's proposals were released in March 1999. The final layout of the new template has been adopted so far by the G10 central banks to disclose their data to the Committee on the Global Financial System of the G10 central banks. It is important to bear in mind that the template is only a recommendation and it is not compulsory for central banks to adhere to it. Copies of the template are accessible at the following websites: IMF (http://www.imf.org) and the BIS (http://www.bis.org). The new template for international reserves has the following distinguishing features: · It is comprehensive with respect to the coverage of both institutions and financial instruments. · It includes more detailed information on both reserves and drains on them. The notion of drains included in the template (referring to both inflows and outflows at a future date) is confined to oneyear period. In more detail, the template is intended to be disclosed by monetary authorities (this category comprises central banks, currency boards, exchange rate stabilisation funds, and treasuries to the extent they perform monetary authorities' functions) and other central government agencies, excluding social security. The definition of the reporting sector is in line with the IMF Balance of Payments Manual. The template covers both on- and off-balance sheet liquid assets, as well as short-term liabilities in foreign currency activities. Only those financial instruments denominated in foreign currency (or indexed to the exchange rate) and settled in foreign currency are included in the template. The rationale for the exclusion of instruments denominated in foreign currency but settled in domestic currency, or vice versa (examples are foreign currency options), is that these types of instruments do not increase or decrease liquid resources.

Page 25

However, although not able to affect the liquid resources in foreign exchange, these instruments can be very important as they could potentially be used in place of more conventional instruments to intervene in the market during a crisis. Therefore, to avoid this type of incentive, the IMF proposed to add a memo item to the original template (IV-1-b) to take these instruments into proper account. The dissemination of the full data relative to the template is prescribed to be on a monthly basis with a lag of no more than a month. Data on central banks' international activities are thus released every month, referring to the previous month. In the course of some of the interviews conducted for the purpose of this study, the question, "What exactly constitutes foreign reserves?" was put. The first category of the IMF—BIS data Template on International Reserves/Foreign Currency Liquidity is finally able to provide a precise, clear and uniform answer to the above question. As shown below, the financial instruments are separated in terms of: · liquidity criteria (gold, deposits); · cashflow characteristics (eg, contingent versus fixed, and fixed terms are broken down into different time profiles according to the residual maturity); and · complementary memorandum items (drawn of unconditional lines of credit, debt indexed to foreign currency). Appendix C also shows how information is to be disclosed by the monetary authorities and other central government.

Page 27

3— Motives for Holding Foreign Exchange Reserves The prime reasons for holding foreign exchange reserves can be summarised as: · liquidity; · risk; and · return. Traditionally, countries have held a stock of international reserves in order to be able to finance balance of payments deficits. However, the level of reserves a country needs depends primarily on the degree of flexibility of its exchange rate, ie, how far it is willing to allow its exchange rate to vary from the level that would otherwise be set by the free market. With totally flexible exchange rates, there would be no need for reserves; but most nations want to be free to alter their exchange rates. In those developing countries that still maintain exchange controls, a significant degree of the country's payments for external trade are processed through the central banks. Thus, there exists a "transaction motive" for holding reserves. Many developing countries, however, removed exchange controls during the 1990s. Accordingly, the holding of foreign reserves for transaction needs has become less crucial. The liberalisation of capital flows during the 1990s has enhanced countries' abilities to draw on global capital markets. The use of international borrowing has been available to both the public as well as the private sector—including those developing economies that have liberalised their exchange controls. In fact the steep rise in international borrowing by the private sector in various developing countries has been one of the major structural changes in the architecture of international finance in the latter half of the 1990s. For a country such as the US, whose currency acts as the global reserve currency, there would be no need for holding any reserves for transaction needs. Arguably there is no case for holding reserves in excess of those that may be needed immediately in a crisis or at very short notice. Adding reserves incurs an opportunity cost. Holding reserves in excess of requirements is, therefore, an expensive luxury. After the fall of communism external reserves have been seen primarily as investments, acting as: · a source of income to be professionally managed; and · a national savings account on which the country could draw on a rainy day. 3.1— Changes in Reserve Holdings As depicted in Table 3.1 and Fig. 3.1, the global size of foreign exchange reserves of all countries of the world has increased considerably in the past decade. If expressed in terms of special drawing rights (SDRs), the world's reserves have doubled in volume between the end of the year 1990 and June 1998. The pace at which this change has occurred, especially during the period from the end of 1992 to end of 1996, is impressive. In those four

Page 28 Table 3.1. Foreign exchange reserves of all countries SDRs per US dollar (end of period)

US $ (billions)

Year

SDRs (millions)

1990

593,607

0.70291

844.5

1991

625,371

0.69909

894.6

1992

673,287

0.72727

925.8

1993

750,192

0.72804

1,030.4

1994

811,254

0.68500

1,184.3

1995

931,704

0.67273

1,385.0

1996

1,080,196

0.69543

1,553.3

1997

1,185,064

0.74115

1,599.0

1998—II

1,228,997

0.75101

1,636.5

1998—III

1,178,580

0.72922

1,616.2

1998—IV

1,161,171

0.71021

1,635.0

1999—February

1,126,305

0.73230

1,548.3

1999—March

1,133,790

073646

1,539.5

1999—April

1,149,330

0.74007

1,553.0

1999—May

1,154,935

0.74358

1,553.2

Source: IMF, 1997, International Financial Statistics, L, no. 10, October; IMF, 1999, International Financial Statistics, LII, no. 8, August.

Figure 3.1. Foreign exchange reserves of all countries. Sources: IMF, 1997, International Financial Statistics, L, no. 10, October, and IMF, 1999, International Financial Statistics, LII, no. 8, August.

years, the volume of the world's global foreign reserves has increased by roughly 60%—an annual average rate of 15%. The surge has coincided with the influence increasingly exercised by the financial markets on the emerging economies. It is worth stressing that the evolution of reserve holdings has followed very different paths across the world. It has increased significantly for

developing countries, whereas it has declined quite substantially for the developed countries. Tables 3.2 and 3.3 depict the opposite tendencies shown by the two groups of countries; the figures from these tables are plotted in Figs. 3.2 and 3.3. During the 1990s, the increase of foreign reserve holdings of the developing economies has been three-fold, and has not shown any tendency for inversion in the last two years, 1998–9. The developed countries increased their foreign reserves until 1996, at an annual average rate of about 8% (the total increase between 1990 and 1996 is about 40%). After that year they started to run down their reserves. Several episodes of financial distress around the world and the contagion effects across countries have played a major role in the changing of reserve strategies.

Page 29 Table 3.2. Foreign exchange reserves of industrial countries Year

SDRs (millions)

SDRs per US dollar (end of period)

US $ (billions)

1991

360,429

0.69909

515.6

1992

356,767

0.72727

490.6

1993

373,683

0.72804

513.3

1994

393,918

0.68500

575.1

1995

441,053

0.67273

655.6

1996

501,666

0.69543

721.4

1997

520,851

0.74115

702.8

1998—II

5l4,741

0.75101

685.4

1998—III

506,195

0.72922

694.2

1998—IV

483,006

0.71021

680.1

1999—February

432,719

0.73230

590.9

1999—March

435,387

0.73646

591.2

1999—April

432,948

0.74007

585.0

1999—May

432,326

0.74358

581.4

Source: IMF, 1997, International Financial Statistics, L, no. 10, October; IMF, 1999, International Financial Statistics, LII, no. 8, August.

Figure 3.2. Foreign exchange reserves of industrial countries Sources: IMF, 1997, International Financial Statistics, L, no. 10, October, and IMF, 1999, International Financial Statistics, LII, no. 8, August.

Although countries have followed different paths in their foreign exchange holdings, all of them have shared a common feature in managing their reserves. Indeed, one common characteristic across all countries has been the tendency to manage reserves according to portfolio investment criteria. Thus, fund reserve managers, either internal or external to the central bank body, have been engaged in finding the optimal level of reserves in terms of the best combination of liquidity, safety and return. Clearly this has led to changes in the level and composition of foreign reserves. In addition to structural changes in reserve management, there have been other changes to adjust the levels and composition of reserves to contingent market circumstances.

This chapter examines what motivates a country to keep a stock of foreign reserves, the determinants of the best level of these reserves, and traces the links between these issues and an economy's macroeconomic conditions. Once the motives for holding reserves are defined, and the best level of reserves is determined, then it is appropriate, in subsequent chapters, to focus on the goals of managing reserves, that is, on the determinants of the composition and the variation of a country's external reserve portfolio.

Page

Page 30 Table 3.3. Foreign exchange reserves of developing countries Year

SDRs (millions)

SDR per US dollar (end of period)

US $ (billions)

1990

217,106

0.70291

308.9

1991

264,941

0.69909

379.0

1992

316,520

0.72727

435.2

1993

376,510

0.72804

517.2

1994

417,336

0.68500

609.2

1995

490,651

0.67273

729.3

1996

578,530

0.69543

831.9

1997

664,214

0.74115

896.2

1998—II

714,256

0.75101

951.1

1998—III

672,385

0.72922

922.1

1998—IV

678,166

0.71021

954.9

1999—February

693,586

0.73230

953.7

1999—March

698,404'

0.73646

948.3

1999—April

716,381

0.74007

968.0

1999—May

722,609

0.74358

971.8

Source: IMF, 1997, International Financial Statistics, L, no. 10, October; IMF, 1999, International Financial Statstics, LII, no. 8, August.

Page 31 Table 3.4. Changes in foreign exchange reserves of the Bank of Korea US $ (millions) Year-end 1998

Year-end 1997 Foreign exchange reserves (A)

Change

20,405.5

52,040.8

31,635.3

Gold

36.9

66.3

29.4

SDRs

58.9

11.4

–47.5

599.3

0

–5993

19,710.4

51,963.1

32,252.7

(11,531.9)*

(3,527.6)*

8,004.3)

8,873.6

48,513.3

39,639.7

Reserve position in IMF Foreign exchange (Deposits with Korean banks, B) Usable foreign exchange reserves (A–B)

*Including US$200 million in swaps with a foreign central bank. Source: Bank of Korea, 1999, Annual Report 1998, Seoul, Korea, p. 64.

US$52.04 billion. The development of Korean foreign reserves from 1991 to 1999 is presented in Chapter 9. This increase in foreign currency holdings is explained mainly by the two reasons. First, Korea experienced substantial capital inflows generated by the current account surplus, and second, Korea received additional funds from international financial organisation (such as the International Monetary Fund, IMF) that made available new resources to be invested in international assets. By April 1998 approximately 99.85% of the foreign currency reserves, the equivalent of US$51,960 million, were held in deposits and securities. To improve the liquidity of its foreign reserve holdings, the Bank of Korea decided to reduce its reserve position at the IMF. 3.2— Structural Changes in Reserves Policies Balancing the basic requirements for international reserves with operating realities is a delicate task. What is rather striking is that, while the reserves build-up of the rest of the world—in particular that of the emerging markets—has been escalating, that of the industrialised countries has been declining (Fig. 3.4). Table 3.5 shows the magnitude of US foreign reserves from 1992 to 1999; these values are plotted in Fig. 3.5. This brings out the irony of the parallel of the reversal of foreign reserve strategy in the US and the rest of the world. Table 3.5 shows that the size of international reserves of the US monetary authorities declined from 33 billion SDRs in 1995 to some 22 billion SDRs in 1999. In US dollar terms it dropped from 45 billions (1995) to some 30 billion dollars in 1999, as shown in Table 3.5. The value of the US reserves in dollars for the considered period was computed by using the corresponding exchange rate per US dollar of each reserve currency for each different year.

Figure 3.4. Structural changes in the level of global reserves

Page

Page 32 Table 3.5. Foreign reserve assets of the US Year

SDRs (millions)

SDR per US dollar (end of period)

US $ (billions)

1991

32,112

0.69909

45.9

1992

29,095

0.72727

40.0

1993

30,237

0.72804

41.5

1994

28,233

0.68500

41.2

1995

33,0280

0.67273

49.1

11996

26,631

0.69543

38.3

1997

22,834

0.74115

30.8

1998—II

23,408

0.75101

31.2

1998—III

23,978

0.72922

32.9

1998—IV

25,568

0.71021

36.0

1999—February

22,348

0.73230

30.5

1999—March

22,386

0.73646

30.4

1999—April

22,170

0.74007

30.0

1999—May

22,009

0.74358

29.6

1999—June

22,055

0.74857

29.5

Source: IMF 1999, International Financial Statistics, LII, no. 8, August.

Table 3.6. Foreign currency holdings of US monetary authorities, based on current exchange rates, 1999 (millions of US dollars) Item

Balance, December 31, 1998

Quarterly changes in balances by source

Net purchases

Effect of

and sales1

sales2

Investment income

Balance, March 31, 1999

Currency valuation

Interest accrual (net)

adjustment3

and other4

Federal Reserve System Open Market Account (SOMA) EMU euro Japanese yen Total

12,824.0

–4,780.5

–18.7

6,846.9

1,418.9

0

19,670.9

–3,361.6

–18.7

118.7 3.0 121.7

–915.9

0

–318.7

0

–1,234.6

0

Interest receviables5

82.8

–29.1

Other cashflow

14.8

–0.9

from investments6 Total

19,768.5

–3,361.6

–18.7

121.7

–1,234.6

–30.0

US Treasury Exchange Stabilisation Fund (ESF) EMU euro

6,494.4

1,081.1

–10.4

45.9

–374.4

0

Japanese yen

9,799.4

–1,407.0

11.9

4.2

–458.4

0

16,293.8

–325.9

1.5

50.1

–832.8

0

Total Interest receviables5

44.3

–12.0

Other cashflow

21.4

–3.0

from investments6 Total

16,359.5

–325.9

1.5

50.1

–832.8

–15.0

Note: Figures may not sum to totals because of rounding. 1 Purchases and sales reflect changes in the foreign currency holdings as a result of the rebalancing between the SOMA and ESF portfolios and a withdrawal of funds from the ESF euro portfolio to meet an IMF quota. 2 Calculated using marked-to-market exchange rates; represents the difference between the sale exchange rate and the most recent revaluation exchange rate in addition to the gain or loss resulting from changes in the market values of the investments sold. (See Table 2 for realised profits and losses on sales of foreign currencies computed as the difference between the historic cost-of-acquisition exchange rate and the sale exchange rate, and the gain or loss resulting from the changes in the market values of the investments sold.) 3 Foreign currency balances are marked to market monthly at month-end exchange rates. 4 Includes the ESF's payment to meet its IMF quota. 5 Interest receivables for the ESF are as of February 28, 1999, and are revalued at February 28, 1999, month-end exchange rates. Interest receivables for the SOMA are carried at cost and are not marked to market until interest is paid. SOMA interest receivables are net of unearned interest collected. 6 Cashflow differences from payment and collection of funds on Japanese Gensaki investments.

Table 3.7. Foreign currency holdings of US monetary authorities (US Treasury) Balance (billions of US dollars)

Weighting (%)

31 March, 1999 EMU euro

7,227.60

47.6

Japanese yen

7,950.10

52.4

Total

15,177.70

100

21 March, 1998 Deutschmark

5,703.10

42.0

Japanese yen

7,860.40

58.0

Subtotal

13,563.50

100

for several reasons, such as: · The Federal Reserve Board has been in existence for some 87 years (founded in 1913), and the US government has been in power for 222 years (founded in 1776). Thus these institutions have consolidated their reputation and credibility. · The US are a relatively closed economy, compared to their domestic dimension, and hence do not need a high level of reserves. · The US dollar is the international reserve currency par excellence, thus the US are not in need of stock foreign curriences.

Page 34

The launch of EMU has raised the question about whether or not the euro can challenge the dollar in its role of primary international reserve currency. An interesting issue that arises is about the future of the ESCB reserves. In particular, if the euro becomes a reserve currency, will the European System of Central Banks reduce their reserves? 3.3— Necessary Qualifications of a Reserve Currency The potential development and speed of development of the euro into a main global reserve currency is dependent on the satisfaction of certain requirements. These requirements represent the basic conditions for a currency to acquire the status of international reserve, and are identified as follows: · The domestic political and financial environments of the currency need to be stable so as to generate confidence in the strength of the currency. · The financial markets in which the currency operates need to be well developed, integrated and internationalised. · The currency should have a recognised tradition of being strong so as to be considered a store of value. · The home country of the currency should have a large share in the world trade, or the currency should be used as a medium of exchange in which international transactions are settled. What chance does the euro stand to satisfy these requirements? 3.4— The Euro as a Reserve Currency As regards the first of the above four conditions, the Euro-zone countries individually benefit from stable political and financial conditions. However, at an aggregate level, a consolidated and coherent pan-European monetary policy is still lacking. In considering the second requisite held by a reserve currency, one could speculate that the euro may face the same difficulties encountered by the Deutschmark prior to the launch of the EMU. First of all, for a series of reasons, financial markets in Germany were not internationally competitive. Second, the Bundesbank did not promote the internationalisation of the Deutschmark— as a reserve currency—because it feared that external conditions could interfere with its monetary policy, which was almost totally devoted to the control of domestic price stability. The euro may share some similarities with the old Deutschmark. First, factors such as dissimilarities in credit ratings and institutional restraints will prolong the subdivisions within the monetary markets of the European member states. The European Central Bank (ECB), as a consequence of implementing financial policies originally carried out by national central banks, would perhaps not engage in activities encouraging global utility of the euro. Of the initial group of countries participating in the European single currency, international advancements that have occurred lately in the majority of them will not have been directed towards their financial markets. The Deutschmark's dominance in the currency market is highlighted in the part it plays as a reserve and reference currency in Europe. The French franc has also risen to an authoritative currency which is demonstrated by its political and commercial relationship with other Francophone countries.

Page 35

As regards the third condition, the euro is still too young a currency and will need time to establish a reputation as a reliable and desirable currency to hold. The European single currency will definitely be able to meet the fourth condition, as the euro members' volume of trade represents a large share of the international trade. Certainly, the European single currency will be used as a guide for the whole of Eastern Europe (awaiting the inauguration of Eastern European countries to the European Union and the European single currency), the Mediterranean Basin, the Balkans, and probably also for Russia and the Asian republics of the Commonwealth of Independent States (CIS). The market anticipated that the transfer of official reserves, mainly dollars, into the European single currency, may be between $US100 and 300 billion. Developing countries hold around 60% of their reserves in US dollars and between 15% and 20% in European currencies. To equalise these ratios, it would be needed to shift around US$100–150 billion. In addition, the market expected that among developed countries, there would be the possibility that Japan would hold a quarter of its US$212 billion in external reserves in euros for the purpose of exchange-rate intervention. The US also accumulated reserves in euros that exceeded its previous holdings of Deutschmarks. The future of the euro as international reserve currency depends crucially on the ability of the EMU country members to establish a tradition of several years of successful pan-European monetary policy-making. In addition to the credibility of the institutions in charge of the Eurozone's monetary policy, the euro will need a liquid market so as to attract prospective euro buyers and sellers. Most crucially, the euro will need to induce a level of confidence among international and domestic investors, so as to be chosen as an investment currency. Only after having satisfied these needs can the euro become a real threat to and a serious competitor of the US dollar. 3.5— Motives for Different Countries At a general level, motives for holding foreign exchange reserve can be divided into two categories: · transactions; and · precautionary. If reserves are held mainly to cope with fluctuation in export receipts, the currency composition should clearly bear some relation to the pattern of the country's trade and investment. The Bank for International Settlements (BIS) and the IMF have recommended that an advisable ratio for determining the size of the reserves is ''three months' worth of imports." For the Euroland area this ratio stood at 4.3. That is the ECB held reserves worth 4.3 months' worth of imports. Table 3.8 depicts the different criteria applied by different countries in holding reserves for international transactions. In discussion with a number of central banks for the purpose of this study, it was evident that the notion of "three months' worth of imports" is regarded as a rather old-fashioned idea and central banks feel they require a great deal more liquidity than in the past. Thus, the months of imports ratio has been allowed to rise in different countries, particularly in emerging markets. China provides a striking example of this new trend. To further illuminate the background behind the reserve build-up by the Bank of China discussed in Chapter 1, some facts and basic statistics on the characteristics of China as far as international trade is concerned are presented here.

Page 36 Table 3.8. Size of foreign reserves relative to countries' imports Country

Months of countries' imports

USA

0.4

France

0.9

UK

1.5

Canada

1.1

Netherlands

1.4

Germany

1.5

Sweden

1.8

Austria

2.4

Australia

2.4

Italy

2.5

New Zealand

2.8

Finland

3.1

Denmark

3.6

Spain

5.6

Japan

5.8

Norway

5.1

China

11.76

· The total amount of Chinese exports in the first six months of 1999 is US$83 billion. In comparing this figure with the volume of exports in the first six months of 1998, it emerges that exports have declined by 4.6%. · The total amount of imports for the first six months of 1999 was US$75 billion. Accordingly, the monthly average figure for imports has been roughly US$7.5 billion of imports per month. The rate of increase in imports in the first six months of 1999, compared with the first six months of 1998, has been 16.6%. · The size of reserves as a multiple of the monthly average volume of imports amounts to 19.6 months of imports (ie, 147 ÷ 7.5 = 19.6 months of imports). · The utilisation of foreign funds for the first six months of 1999 has been US$18 billion. · The decline in utilisation of foreign funds, when compared with the first six months of 1998, is therefore 9.2%. Different central banks apply different terminologies for the motives behind holding reserves. Some central bank's examples of motives for holding foreign exchange can be given below, eg, those of the New York Federal Reserve Bank, the Reserve Bank of Australia and the Central Bank of Malta. · The Reserve Bank of Australia's motives for holding their reserves are: conservatism, liquidity, safety and return. · New York Federal Reserve Bank feels there is really no motive for holding their reserves. It says it does not need to hold any reserves. What the bank holds is more a matter of accident than a "need" for it. The dollar is a free-floating currency.

Thus, there is no need to hold any reserves whatsoever. The Fed feels that if it liquidated all of its foreign exchange reserves, it is likely that the market would misinterpret its actions. It could be more disruptive of the workings of the market if the Fed were to dispose of all of its foreign exchange reserves. · The Central Bank of Malta's motives and strategy for holding reserves can be summarised as follows: half the reserves are held for liquidity

Page 37

reasons and the other half for strategic reasons. The latter motive itself is split into sub-categories, namely, growth and income. Other central bankers define their motives for holding reserves as: · liquidity; · investment purposes or "store of wealth"; and · Influencing the exchange rate. The first of the above motives (liquidity) has been recognised by developing countries as the key reason for increasing their holdings of reserves. Financial crises have highlighted the importance of liquidity. However, at the end of the discussion on different motives for holding reserves and use of reserves, it is not entirely clear whether at the time of a currency crisis all of the reserves can be used to sustain the currency or not. One way to re-phrase the question would be as follows: Has a country ever used its entire stock of reserves to defend its currency in the event of a speculative attack? That is, once the reserves are allocated to different ends, can central banks still use the rest of the reserves for the purpose of supporting a currency? As regards the holding of reserves for precautionary motives (ie, to intervene in case of an attack), one could argue that instead of holding the reserves, a country could borrow in international capital markets whenever the need arises. Or it can arrange with other central banks that whenever a speculative attack occurs they can help each other—the so-called "mutual line of credit". How different is coordinated intervention? To complicate the matter even further, at the time of the Exchange-Rate Mechanism (ERM) crisis, the UK government announced that it had borrowed the equivalent of US$7 billion to defend the pound. The question is: Are the assets that are managed externally brought in to defend the currency at the time of the crisis? The answer to this kind of question varies according to the objectives of a country's monetary policy. 3.6— Objectives of Monetary Policy The issue of choosing the optimal level of reserves, as well as their composition, is a relatively new one. The gold standard system and, to some extent, the dollar standard system as designed at Bretton Woods, did not allow countries to address these types of issues. The external value of the currency, and therefore the foreign exchange policy, dominated the conduct and the objectives of a country's monetary policy. All countries, with the exception of the US, had very little discretion—if any—in both choosing the targets and the instruments of monetary policy. It has been only after the fall of the fixed exchangerate regime system, that central banks have acquired degrees of freedom and functional discretion to reconcile domestic and external targets of monetary policy. In an international environment where each country decides if and when to use its international reserves for official interventions, the foreign exchange policy becomes a crucial factor in the analysis of a country's reserve position.

In sustaining its own currency, a country reduces its reserves. However, with few exceptions, interventions are not always foreseeable. Various factors may induce a central bank to choose not to intervene, or to intervene, thus changing its reserves. In some instances, interventions could have the purpose of signalling the direction of future monetary policy actions. In other

Page 38

cases, a benign neglect of the value of the currency could be preferred, so as to take further action only in the extreme case of speculative attacks. In other instances, when a country wishes to insulate the domestic economy from external shocks or policies, sterilised interventions could be carried out. Through sterilisation, which offsets net inflow or outflow of new monetary base, the supply of money is kept intact. Thus, the level of reserves may vary depending on the objectives of the foreign exchange policy, the objectives of the domestic monetary policy, and the balance of these two sets of objectives. An interesting issue is whether a central bank with more transparent monetary policy targets and instruments can avoid speculative activities. The case of Denmark is presented here as an example of different exchange-rate strategies. 3.7— Monetary and Exchange-Rate Policies in Denmark For almost 20 years, the basis of economic strategy in Denmark has been exchange-rate stability. The country has been able to lessen the level of inflation by ensuring that the value of its currency, the kroner, is maintained at a constant value against the currencies of those countries where inflation is low. The exchange rate in Denmark, being invariable, explicitly separates tactics of monetary and fiscal nature. The currency exchange rate is stabilised by monetary strategy, but improvements with regards to the issues of wages and prices are managed by fiscal strategy. In 1998, the Danish kroner oscillated insignificantly against the German Deutschmark. However, during times when the Danish currency was facing difficulties, the Danish central bank (the National Bank of Denmark) bought the domestic currency and sold its foreign reserves to sustain the kroner. But in opposing circumstances, domestic currency was sold in exchange for more foreign currency. By engaging in this procedure, the level of foreign-exchange reserve holdings fell by 29 billion kroner. September and May 1998 saw the kroner face further strain and, as a result, the government-set rate of interest was increased by the Danish central bank. During the end of 1998, and just into 1999, the central bank endeavoured to coordinate interest rate reductions in line with foreign exchange accumulation. The simultaneous reduction of interest rates in the 11 countries participating in the European single currency induced the Danish central bank also to reduce its rate of interest at the end of 1998. Denmark's policy with respect to foreign exchange has not been altered since the European single currency came into existence in January 1999. However, attention will now be focused on supporting its steady currency against the euro through the recently formed second Exchange-Rate Mechanism. The intention of ERM II is to ensure that the exchange-rate rootedness between the single currency area and European Union participants not undertaking the Euro. Within the system of the ERM the euro is the anchor currency (in place of the Deutschmark under the old ERM). Prior to the launch of the euro the Danish kroner was fixed by the Danish National Bank against the German currency at its median rate, and this will carry on under the second exchange-rate mechanism. However, the euro will take up the role of the Deutschmark. According to the strategy of the invariable exchange rate, if the Danish currency encounters any obstacles or difficulties, then action must be taken to counteract these, in the form of foreign exchange transactions or changes in the rates of interest. If necessary, both may be carried out. As a member of ERM II, the Danish currency has a median conversion rate with the euro of just under 750 kroner to every 100 euro. The kroner also operates within oscillation limits of plus or minus 2.25%. The value of

Page 39

the currency (at its median rate) against the European single currency is dependent upon the exchange rate that existed between the kroner and the German currency, as well as the exchange rate between the German currency and the European single currency. Strategies with regards the invariable exchange rate are officially sustained through ERM II. However, the low volatility of the Danish kroner cannot be ensured by such a mechanism alone. For this to be the case, the country's economic tactics need to be uniform and stable. The fact that Denmark has accepted the second exchange-rate mechanism shows that its executive body intends to incorporate an economic strategy that complies with the conditions of the invariable exchangerate strategy. Although Sweden and the UK opted out of ERM II, Greece has chosen to become involved. The second exchange-rate mechanism allows currencies to oscillate within standard limits of plus or minus 15% against the European single currency, limits within which the Greek Drachma operates.

Page 41

4— Composition of Foreign Exchange Reserves The issues pertaining to "motives", "composition" and "benchmarks" with respect to official reserves holdings as subject matters (and, hence, chapters in this book) are somewhat inter-related. It is important to distinguish between them as topics and questions to be analysed and studied. Perhaps the best way in which one can distinguish between these issues in broad terms is as follows: · "Motives" relates primarily to the size of official reserves. It focuses on their volume, their structural changes, ie, their growth as well as their acceleration and deceleration. · The "composition" of the country's reserves holdings focuses on issues related to the selection of the currencies and securities that best serve the motives laid out for the country's foreign reserve. · The notion of "benchmark" relates specifically to the weights earmarked for different currencies and securities. Thus, it gives the breakdown of the portfolio of official reserves in terms of quantified weights assigned to different currencies and different financial instruments. Is the composition of foreign exchange reserves held by a country chosen in tandem with the determination of motives for holding reserves, or is the composition of the reserves picked subsequently? In other words, should the motives be identified first before the country moves to select the composition? Our survey shows that in practice the size and composition of official reserves have in general an historical dimension to them. That is, their size and composition are due to past conventions, as well as to the prevailing economic conditions of the country. Thus, the parameters of the reserves are not so much the result of a thorough appraisal and review of motives and a subsequent assessment of the composition. "They are what they are," was the comment of one central banker. In most cases when the officials of a central bank or ministry of finance were questioned about these issues, they did not seem to have a ready explanation. By and large in forming and selecting the composition of reserves, two principal factors are considered by many central banks: · external debt; and · imports so that the mixture best reflects the foreign currencies relevant for and linked to these principal variables. Under the constraints created by the servicing and of the repayment of the external debt, as well as by a country's trade commitments, a central bank selects both types of currencies and types of financial instruments in the effort to reconcile liquidity, risk and returns considerations. Examples of several central banks' reserve strategies are presented in the following sections. 4.1— Composition by Currency Australian foreign reserves are allocated in assets denominated in the currencies of the US, Germany and Japan. The targeted currency distribution has the following weights: 40% for US dollars, and 30% each for the euro and the yen. This currency mix and weighting, reported in Table 5.2 in Chapter 5, has been kept intact compared with the year prior to the launch of the EMU.

Page 42 Table 4.1. Breakdown of foreign exchange reserves of the Swiss National Bank by currency

US dollar US dollar hedged Deutschmark

43% 9% 26%

Deutschmark hedged

6%

Dutch guilder

3%

Pound sterling

3%

Danish kroner

2%

Yen

5%

Source: Swiss National Bank, 1999, 91st Annual Report, 1998.

The composition of the reserve portfolio of the Swiss National Bank for the year 1998 is reported in Table 4.1. Foreign investments denominated in the US dollar represent by far the main item of the Swiss reserve portfolio, with a share of 43%. This share used to be even bigger in past years. In fact, as a result of the restructuring process of foreign exchange investments, started in November 1997, the National Bank has reduced the dollar share further in favour of investments in Deutschmarks, pounds sterling, Dutch guilders and Danish kroner. During the Autumn of 1998 the composition of reserves of the Bank of Korea was 75% US dollars, 15% European currencies and 10% yen, Australian dollar and special drawing rights (SDRs). 4.2— Composition by Type of Financial Instrument International reserves represent almost half of the total assets of the Reserve Bank of Australia's balance sheet. The exchange rate policy followed by the Reserve Bank of Australia requires the immediate availability of foreign exchange reserves for intervention in the foreign exchange market to sustain the value of the Australian dollar. Thus the Bank gives priority to liquidity and risk criteria to hold foreign currency investments. After considerations such as safety and liquidity, the Bank aims to maximise the return on reserve portfolio, by choosing a combination of return and risk according to a benchmark portfolio. The management of the Australian foreign currency investment portfolio is carried out by a group of internal managers of the Bank, who follow some basic guidelines approved by the Governor about both the type of financial investment as well as the type of currency allocation. The following table indicates the type of financial assets held by the Bank, and the credit risk of the Bank's investment portfolio. Most of the assets are government securities with a maximum maturity of 10 years, whereas the average duration of the portfolio is targeted at about 30 months. A small percentage of the Bank's total assets, both domestic and international, is held in gold. Although returns from gold continue to fall, the Bank still utilises it as an investment vehicle. Since 1997, the expectations of decreasing prices of gold have induced the Bank to sell large amounts of its gold reserves. The reduction in gold reserves has been by approximately about 66%. Most of the remaining stock of gold owed by

the Bank is loaned to financial institutions in the gold loan market. During the years 1998 and 1999 the gold loan market turned out to be very active for two main reasons: a strong demand, and a new supply of gold loans offered by some large European central banks that have entered the market to lend their holdings of gold reserves. The strong demand of gold loans was triggered by the fact that speculators and producers of gold, in fear that the price of gold would plunge, had

Page

Table 4.2. Concentration of credit risk in the Bank of Australia's investment portfolio, 1999

Security type

Risk rating of security issuer*

Risk rating of counterparties*

% of total assets portfolio as at June 30, 1999

Domestic government securities Holdings of Cormonwealth

AAA

n/a

Securities sold under

AAA

AAA

0.0

repurchase agreements

AAA

AA

1.4

AAA

other

0.0

Securities held under

AAA

AAA

0.0

repurchase agreements

AAA

AA

AAA

other

1.5

AA

AAA

0.0

AA

AA

3.3

AA

other

0.1

other

other

0.0

Holdings of securities

AAA

n/a

21.4

Securities sold under

AAA

AA

4.6

repurchase agreements

AAA

other

2.3

18.9

19.0

Foreign investments

Securities sold under

% of total assets portfolio as at june 3

Page 44 Table 4.3. Foreign exchange reserves of the Swiss National Bank by debtor category

Government securities Securities with indirect government guarantee International institutions Banks

73% 9% 11% 7%

Source: Swiss National Bank, 1999, 91st Annual Report, 1998.

international organisations, which amount to 11% of total foreign exchange reserves. A small amount of international reserves is held in time deposit at some main foreign banks, as depicted by Table 4.3. By making an appropriate use of interest rate futures, the Swiss National Bank has been able to extend the duration of its reserve portfolio to three years. 4.3— Shifts into Euros Prior to the launch of the euro many countries examined whether to manage individual portfolios for the different countries of the European Union they were still holding, or to substitute them with a singular one for the Eurozone region as a whole.* However, it appears that the process of the change is rather slow, which reflects central bankers' cautious behaviour with respect to European Monetary Union (EMU). It has been evident in the first year following the launch of the single currency that most of the central banks outside the euro area did not alter the composition of their reserves with respect to the EMU-zone. One such example is the Reserve Bank of Australia. Before the onset of EMU there were market expectations that there would be portfolio changes out of dollars into euros of the order of US$100 to US$300 billion. This massive shift has not occurred as yet, partly because of the lack of confidence in the new currency, and partly because of the "wait and see" attitude adopted by reserve managers in the early part of the euro's life. Suffice it to say that the euro as a currency will not be functional as proper legal tender until June 2002. Prior to EMU there was also market expectation that the central banks that are the participating members of EMU would be disposing of some of their assets owing to the disappearance of a part of their currency risks. However, at the outset of EMU, the participating central banks chose not to reduce the volume of their foreign exchange holdings. In fact, there was a substitution of Deutschmarks into euro in the run-up to the euro on the part of some central banks, such as National Bank of Austria. The US is one of the few countries that actually increased its weighting in euros with the onset of EMU (see Tables 4.4–4.7). As illustrated in Tables 4.5 and 4.7, the US Treasury's holdings of foreign reserves have changed in two respects. First, the euro has replaced the Deutschmark as a reserve currency. Second, as predicted by the market during 1997, the weightings of the only two currencies held by the US Treasury have changed. The share of Japanese yen has reduced from 58% to 52%, while the share of the other reserve currency (ie, the euro now) has increased correspondingly. This shift into the euro represents a considerable structural change, especially if one considers that

the weight of Deutschmark in the total portfolio remained unchanged from 1997 to 1998, as shown in Table 4.6. *H.M.

Scobie et al., 1997, The Cost and Time Scale for the Switchover to the European Single Currency, International Securities Markets Association (ISMA), Zurich.

Page 45 Table 4.4. Foreign currency holdings of US monetary authorities, 1999 (Federal Reserve System) Balance, June 30, 1999 (billions of US dollars)

Weighting (%)

EMU euro

7,227.60

47.6

Japanese yen

7,950.10

52.4

Total

15,177.70

100

Table 4.5. Foreign currency holdings of US monetary authorities, 1999 (US Treasury) Balance, June 30, 1999 (billions of US dollars)

Weighting (%)

EMU euro

7,236.6

47.7

Japanese yen

7,950.1

52.3

Total

15,186.7

100

Table 4.6. Foreign currency holdings of US monetary authorities, 1997–98 (Federal Reserve System) Federal Reserve

Balance, December 31, 1997 (billion of US dollars)

Balance, March 31, 1998 (billion of US dollars)

Deutschmark

11,486.7

67%

11,265.9

67%

Japanese yen

5,473.4

32%

5,361.4

32%

Subtotal Interest receivables Other cashflow

16,960.1 82.9

16,627.3 0.5%

73.0

3.2

10.7

17,046.2

16,711.0

0.4%

from investment Total

Table 4.7. Foreign currency holdings of US monetary authorities, 1997–98 (US Treasury) Federal Reserve

Balance, December 31, 1997 (billion of US dollars)

Balance, March 31, 1998 (billion of US dollars)

Deutschmark

5,815.6

42%

5,703.1

42%

Japanese yen

8,024.6

58%

7,860.4

58%

Subtotal Interest receivables Other cashflow

13,840.2 38.5

13,563.5 0.3%

36.7

5.9

18.2

13,884.6

13,618.4

0.3%

from Investment Total

The composition of the Federal Reserve's holdings of foreign reserves is totally reversed compared with the currency distribution of the Treasury: it is heavily skewed towards the Deutschmark. In fact almost 67% of the reserves are held in Deutschmark, whereas the remaining share is held in Japanese yen. Since the Fed holds a larger volume of reserves than the Treasury, it follows that the amount of Deutschmark held by the Fed is almost as twice as much as the amount of Deutschmark held by the Treasury.

According to some predictions formulated before the launch of the euro, the shifts of reserves from dollars into euros would involve some largescale operations. If the developing countries, which at the onset of the euro held 60% reserves in dollars and 15–20% in European currencies, wished to equalise these ratios, then they would pour about US$100–150 billions into the market. Moreover, Japan might be interested in shifting some US$50 billion of its US$200 billion of foreign reserves into euros, so as to be able to intervene more effectively in the foreign exchange markets. Within the EMU-zone, most of the central banks outside the European Union area are not inclined, at least initially, to alter the composition of their EMU reserves portfolios. Many of the central banks outside EMU are

Page 46

examining whether to manage a separate set of portfolios for the different EU currencies that they currently hold, or to replace them with the European single currency. As EMU acquires the status of a credible, solid and durable system, more and more reserve assets denominated in dollars will be shifted into euros.

Page 47

5— Benchmarks 5.1— Definition The term ''benchmark" is used in a variety of ways. It is in effect a yardstick that is preset—against which other alternatives are measured. As explained in Chapter 4 in relation to reserve management, one of the uses of the terminology "benchmark" relates specifically to the quantification of the goals of holding official reserves in terms of the following three key variables: · risk; · liquidity; and · return. The monetary authority, thus sets a quantified measure determined a priori for the components of the reserves based upon which investment decisions are carried out. This measure, labelled the "benchmark", portrays the weights earmarked for different currencies and securities within the portfolio of official reserves. In this respect it gives a breakdown of the portfolio of official reserves in terms of the proportions of the reserves assigned to different currencies and different financial instruments. A clear example is given in Table 5.2, which shows the composition of the benchmark portfolio of the Reserve Bank of Australia for 1998 and 1999. The term "benchmark" can also be used in another context when it refers to a "reference rate of return", ie, a rate of return against which the performance of the portfolio is judged. 5.2— Asset Allocation Practices of Central Banks Before explaining the intricacies of benchmarks set for the portfolio of reserves, it is worth looking into how in practice central banks manage their reserves.* The official reserves of countries around the world are managed in many different ways. The foreign exchange reserves are most commonly split into two different categories: · cash; and · bonds. A relatively large proportion of the reserves are normally held in cash for the prime reason that the reserves have to be readily available for the use of central banks for any necessary intervention. At the same time the monetary authorities who are looking to place cash will look for the best rate at which to place the cash. Generally the return on holding cash is the interest rate on deposit accounts of commercial and investment banks. Thus, the return on cash is the rate that commercial and investment banks can offer central banks on their cash. Another alternative to deposits used often by the central banks is to place the cash in a repo agreement with the banks. Repo is short for "repurchase agreement", a transaction whereby one party sells a security to another with a simultaneous agreement to repurchase the security at a fixed future date for a stipulated price.

*See

also P. A. Aronson, 1998, "New Guidelines for the Investment of Foreign Exchange Reserve," Economic Bulletin, issue 3.

Page 48

Banks in the private sector, especially investment banks, look for cash to fund their bond positions. The way to match these two interests is by the central banks giving the banks cash and the banks lending their securities to the central banks as collateral at a certain rate for the period involved. This period will most often be between one day and one week. The advantage for the central banks is that they can often achieve higher rates on repos than on straight deposits. Moreover, they hold collateral in exchange for their cash. With a straight deposit they have the full risk of the counterparty/bank, which is the commercial bank with whom they have placed their cash. Central banks can also lend specific bonds to commercial/investment banks. In case an investment bank has a "short position", ie, having sold a bond that the investment bank does not hold, it will look to borrow the bond from another party who holds it. The price for borrowing a specific bond varies, but it is always at a lower rate than normal deposit rates. An investment bank borrows a bond and gives cash at, say, the deposit rate at commercial banks minus 50 basis points. The potential owner/lender of the bond receives cash for a given period below deposit rates and can then place the money on deposit and thereby earn the difference, in this case 50 bp or 1/2%. As the basic criterion for reserves is that they need to be easily available, cash is often used as the "benchmark" (in this case implying the reference rate) for the whole of the reserves. For this purpose, the money market rates are the minimum the central bank sets itself to achieve for the return on their reserves. Such money market rates can be one week, one month, or three months "libor"* deposit rates that are used as the benchmark. It should be noted that the term "benchmark" in this context refers to the reference rate of return and not the composition of the portfolio of reserves. A certain percentage of the reserves is often invested in fixed income instruments, ie, within the international bond market. The main investment criterion is still that the bonds have to be readily available. This implies that central banks would only purchase liquid bonds—mainly with the kind of size that makes them easily tradable. Most central banks buy government bonds of the main economies in the world, often concentrating on government bonds of the US, Germany and Japan. Traditionally a somewhat smaller component of the reserves was devoted to other European bonds. For the central banks who purchase bonds with longer maturities (ie, move towards the longer end of the yield curve) the behaviour is more similar to that of portfolio managers within the private sector, since they adopt benchmarks from the big investment banks such as JP Morgan and Salomon Smith Barney. They will follow their indices as their benchmarks for part of their portfolios and the reserve managers will try to see if they can outperform their benchmark. 5.3— Duration Central banks can normally buy government bonds up to 30 years' maturity. However, they have to adhere to a certain duration on the overall portfolio. The "benchmark duration" varies a great deal, but it is rare to come across a duration chosen by a monetary authority that is longer than three years. This obviously means that most central banks will be far more active in the shorter end of the yield curve (1–5 years) when trading in bonds. Often they try to keep the reserves at a certain duration, which means that they will have to "roll" their portfolios continuously as the maturities become shorter. This often happens on a 1- to 3monthly basis. They will then sell shorter-dated paper to buy slightly longer-dated paper, which will *London

Inter-Bank Offer Rate.

Page 49

adjust the duration accordingly. Again, some central banks have constructed their own benchmarks that reflect the specific structure they have in their reserves. Duration generally is a measure reflecting how risk averse a central bank is. For example, a central bank with a duration of 18 months is more risk averse than a central bank with a duration of 30 months. Moreover, within a central bank there may be two types of portfolios, short-term and longterm, eg, Norway (discussed further below). Whereas the duration for the short-term portfolio of the Bank of Norway is between one and two years, the duration for the long-term portfolio is between five and seven years. Central banks also look at the duration of investment bank benchmarks. For example, the duration of the benchmark of Salomon Smith Barney's government bond is five years. 5.4— Trading Size of Central Banks Central banks are important players in the world's fixed income markets. They have vast sums to invest and when they trade their portfolios it is rarely in a small size. Therefore, it is mainly the biggest market players that see the bulk of their trading, as the smaller banks cannot manage their trading size. Central banks often have restrictions on which banks they can have as counterparties. Most often a rating of at least single A from one of the main rating agencies is necessary for a bank to be taken into consideration as a counterparty. Finally, a large proportion of central banks have some of their reserves managed outside the central bank, ie, with external fund managers. This is a way for them to see how other fund managers manage money. They will be given a copy of all the trades done externally and can potentially shadow that with the reserves they manage themselves. 5.5— Some Benchmark Examples Some examples of portfolio benchmarks are given below. 5.5.1— Norway The central bank of Norway (Bank of Norway) has two types of portfolio: "long-term" and "shortterm". The benchmark for the short-term portfolio is shown in Table 5.1 below. Table 5.1. Composition of the benchmark of the short-term portfolio of the Bank of Norway, 1999

Euro

50%

US dollar

20%

UK sterling

20%

Japanese yen

10%

Source: Bank of Norway, 1999.

5.5.2— Australia Since the 1990s the Reserve Bank of Australia has adopted a benchmark portfolio that reflects the

Bank's objectives in terms of liquidity, risk and return. The long-run investment allocation chosen as benchmark comprises assets of

Page 50 Table 5.2. Composition of the benchmark portfolio of the Reserve Bank of Australia in 1998 and 1999 US

Japan

Germany

Asset allocation (%)

40

30

30

Currency allocation (%)

40

30

30

Duration (months)

30

30

30

Source: Reserve Bank of Australia (1999), Report and Financial Statements, p. 18, and Reserve Bank of Australia (1998), Report and Financial Statements, p. 40.

three countries: the US with a share of 40%, Japan with a share of 30%, and Germany with a share of 30%. The currency distribution of the benchmark is managed independently from the investment allocation, but does not differ from the latter. Thus, in the benchmark portfolio, 40% of the foreign investments are in US assets, and are denominated in US dollars. To understand this point, one should consider that, technically, the investment composition and the currency composition of an international portfolio are two distinct concepts. In integrated and control-free financial markets it is possible to invest in a US asset that is denominated in a currency different from the US dollar. After the launch of the euro this distinction is even more important. At one level an investor needs to decide how much to invest in euros and how much to invest in other currencies. At another independent level an investor needs to decide the type of investment to undertake. For instance, a French security might have different characteristics from a German security, although both are denominated in euros. In this respect, the Bank of Australia benchmark includes euro-denominated assets created by German institutions. Examples of the latter are any of the listed federal government bonds of Germany falling due after January 20, 1999—bonds that were re-denominated in euros at the beginning of January 1999. The overall duration of this optimal portfolio has a benchmark of 30 months, although some government securities have a maximum maturity of 10 years. The benchmark portfolio of the Australian Bank is depicted in Table 5.2. The investments in foreign reserves are conducted by an internal group of portfolio managers. Over the past year, the decisions of these reserve managers have been affected by the low yield of US bonds, by the dramatically low level of Japanese bond yields, and by the fluctuations of the yen and the depreciation of the euro. The reaction of the Reserve Bank of Australia to this market environment unfolded in two directions: the Bank reduced the amount of its holdings of Japanese assets in favour of US and German securities, and it reduced the duration of its Japanese portfolio. Consequently, the duration of the Japanese component of foreign reserves underperformed the benchmark. The overall performance of the portfolio was 4.9%, which was more satisfying than the returns earned during the past three years, but it was still below the targeted 5.1% of the benchmark portfolio. 5.5.3— Hong Kong The foreign reserves of Hong Kong are held by the Exchange Fund, which sets out objectives and strategies for the management of foreign currency assets. However, the responsibility of managing the reserves of the Fund is statutorily given to the Reserves Management Department of the Hong Kong Monetary Authority (HKMA). While the main objective of the Fund to maintain the stability of the external value of the Hong

Kong dollar has not changed, the past year has witnessed a crucial change in the management of official reserves. The

Page 51 Table 5.3. New investment benchmark of the Exchange Fund of the Hong Kong Monetary Authority, 1998 New investment benchmark

Previous investment benchmark

Bonds

80%

90%

Equities

20% (Hong Kong: 5%)

10% (Hong Kong: 0%)

Currencies

80% US$-bloc

70% US$-bloc

15% European bloc

20% European bloc

5% Yen

10% Yen

Source: Hong Kong Monetary Authority (1999) Annual Report 1998, p. 75.

strategy for long-term asset allocation has undergone a substantial modification, as the result of the merging of the Land Fund assets into the Exchange Fund assets, and of the dramatic growth of official reserves. These new developments have induced the Exchange Fund to adopt the view of a more active management of the reserves, geared to achieve better returns on international assets. Thus, the beginning of 1999 has coincided with the abandonment of the old system according to which the reserves were deposited with the Exchange Fund at the market interest rate. The new allocation strategy is in line with a more modern, efficient and profitable practice of reserve management. The new investment benchmark is presented in Table 5.3. In the new benchmark the share of the equity investment and that of the currencies have increased. The former has doubled from 10% to 20%. This change in the equity share of the portfolio is intended to preserve the long-run real value (purchasing power) of the Exchange Fund assets. As regards the currency composition, the US dollar bloc has increased its share, against the decrease of the euro and the yen shares, respectively. The rationale behind these changes resides in the objective set by the Fund to guarantee the credibility of the currency board exchange rate system, based on the fixed correspondence between the monetary base and reserves in US dollars. The way that a currency board system operates is similar to the gold standard in that it requires 100% international reserve backing of the monetary base by the nation. In a currency board system, the authority issuing the domestic notes announces a fixed exchange rate against some other foreign currency and, at that rate, the authority carries out any trades of domestic currency notes against the chosen foreign currency that the public wishes to initiate. Since the currency board is prohibited from acquiring any domestic assets, the currency is automatically and entirely backed by foreign reserves. In this regard, it is interesting to note the problem and the solution envisaged by the HKMA during the international financial crisis in 1998. Technically, since a currency board cannot acquire domestic assets (to avoid creation of money supply not backed by international reserves), it cannot lend currency to domestic banks in times of financial panic and low liquidity of the system. Hong Kong's crisis in 1998 illustrates the problem a currency board can face in coping with financial distress, and the reforms introduced after the crisis show the sort of defence mechanism envisaged by the Hong Kong Government to avoid such a problem. The financial instability in the Asian regions, as well as in Russia and Latin America,* put the Hong Kong dollar under a great deal of pressure, as speculators engaged in large-scale sales of the currency. In January and mid-June of 1998 the waves of speculative attack resulted in a reduction of inter-

*See

also S. M. Samadian and G. Croft, 1999, "A Dynamic Model of Capital Flows," Economic and Financial Modelling, 6, no. 1, Spring, p. 3.

Page 52

bank liquidity, as the HKMA passively sold the reserves of US dollars to buy Hong Kong dollars. The Hong Kong Interbank Offer Rate (HIBOR) rose. In August 1998, Hong Kong experienced a new wave of speculative activities. However, this time the speculative attacks did not cause a dramatic change in the inter-bank liquidity of the system. The explanation of the August 1998 situation is to be found in the budgetary needs of the Treasury, which, with its deficit, counteracted the effect of speculative activities by creating a demand for Hong Kong dollars that absorbed the sales of the currency. What happened was the following: HKMA passively acquired the Hong Kong dollars sold by speculators in the market, but at the same time, HKMA funded the treasury budgetary needs by reselling Hong Kong dollars and buying back reserves from the treasury. The experience suggested that to avoid liquidity problems, and to make it more difficult for speculative attacks to succeed, the system needed to enhance the banks' possibility of borrowing by making use of the abundant stock of official reserves in US dollars. To strengthen the currency board system and reduce speculative activities, the government adopted a series of seven measures against market manipulations. Among these measures, the Convertibility Undertaking of the HKMA, and the discount window, were introduced specifically to inject liquidity in times of financial stress. Under the Convertibility Undertaking, HKMA converts the Hong Kong dollars clearing accounts of the licensed banks into US dollars at a rate of 7.80. The discount window allows banks to borrow either through repo operations or by using collateral. 5.5.4— Malta The Central Bank of Malta's benchmark for foreign exchange reserves are as follows: · 50% of the reserves are held for liquidity reasons; and · 50% for strategic reasons. The strategic motive itself is split further into two subcategories, namely: · growth; and · income. 5.5.5— Switzerland The foreign exchange reserves of the Swiss National Bank are held in liquid financial instruments. The Bank does, however, hold a fraction of its reserves in time deposits in prime foreign banks. Investing in liquid securities makes them more accessible, allowing the Bank to dispose of its investments quickly whenever the need arises. Table 5.4. Foreign exchange investments of the Swiss National Bank Foreign exchange reserves by debtor category

(%)

Government securities

73

Securities with indirect

9

Foreign exchange reserves by currency Dollar Dollar-hedged

(%) 43 9

government guarantee International institutions Banks

11 7

Deutschmark

29

Deutschmark-hedged

6

Dutch guilder

3

Pound sterling

3

Danish kroner

2

Yen

5

Page 53

5.6— Changes in Benchmarks Although managers of central bank reserves have reached the consensus that liquidity return and risk objectives of institutions should be mirrored in benchmarks, the criteria for changes in benchmarks have received little attention. Benchmarks will need to be changed in line with two factors: · changes in objectives; and · changes in market risk. Thus, if volatility increases, a change in benchmark should occur through an adoption of, say, a shorter "duration". Finally, it is worth noting that a comparison of performance under the old and new benchmarks is advisable.

Page 55

6— Currency Baskets and Official Reserves Policies When a country chooses to link its exchange rate to a currency basket, the country's official reserves policies are strongly affected by it. In other words, the composition of the foreign exchange reserves often closely reflects that of the weights assigned to the components of the currency basket. 6.1— Definition A "currency basket" is in effect the mixing of a group of (or sometimes only two) currencies. Such a basket thus represents a unit that is formed from two or more currencies and is constructed as a weighted average of these currencies. A country can link its currency to a basket by setting the basket as a target against which it can have some form of a peg to its currency. The country can choose to have either a fixed peg or a floating peg; the latter allows the currency of the country to oscillate within a band. Currency bands can vary from 1% either side of a central rate to as large a width as 15% either side of a central rate. There are no conventions or norms for currency bands. The sizes of the bands are chosen by different countries based on how far they wish to allow their currencies to fluctuate against a given currency basket. The purpose of forming a currency basket is to reduce exposure and risk, for it provides the advantage of diversification. In this respect such composite currency units are designed to create a more even movement compared with a link solely to one currency. For this reason some countries, eg, some of the East European countries, opt to peg their currencies to a basket of other currencies. The mixture of currencies that a country selects to form its currency basket primarily reflects the country's international trade. A few examples of the composition of currency baskets in different countries are presented in this chapter in Tables 6.1–6.5 and Figs. 6.1–6.5. 6.2— Composition of Currency Baskets The examples of currency baskets shown here reflect the combination of the currencies before (and after) the arrival of the European single currency.* The composition inevitably had to be changed with the introduction of the EMU. Wherever a currency of a euro-11 country appeared in a portfolio, it had to be converted into the euro. The examples of currency baskets presented here are those for Hungry, Poland, Malaysia and Malta. The composition of the currency basket for Hungary prior to the launch of the euro is shown in Fig. 6.1, and Table 6.1. This basket of currencies with these weights was active in Hungary from January 1, 1997. The choices that have faced a central bank for introducing the euro into its currency basket and foreign exchange reserves are discussed in more detail below. In this example the choice for Hungary was fairly straightforward. All the Deutschmarks had been automatically converted into euro when EMU began. However, other options are discussed in the section below. The basket of currencies in Poland from October 1991 was weighted in the manner shown in Table 6.2 and Fig. 6.2. The National Bank believed that, "despite the passage of time, the currency composition of the official *See

also H. M. Scobie, F. Peters, K. Ho and A. Stefanovic, 1998, "Reserve Management with the Birth of Euro", Economic and Financial Review, 5, no. 4, Winter, pp. 177–96.

Page 56

Figure 6.1. Hungarian currency basket (1998) Table 6.1. Hungarian currency basket before the launch of the euro Currency

Weights (%)

Deutschmark

70

US dollar

30

reserves in force since 1991 continued to produce the desired result for the country."* Poland restructured its currency composition with the launch of the euro. It eliminated two European non-EMU currencies (ie, the UK pound sterling and the Swiss franc) and converted the Deutschmark and the French franc, which are currencies of EMU member countries, into the euro. Through this process the country simply brought its euro weighting of the basket to 55% (being the sum of 35% Deutschmark, 5% French franc, 10% UK pound sterling and 5% Swiss franc). The underlying rationale behind the restructuring was as follows: · The removal of the two non-EMU currencies, ie, the UK pound sterling and the Swiss franc, was on the grounds that since both of these were

Figure 6.2. Composition of currency basket for Poland Table 6.2. Composition of currency basket for Poland, 1998 Currency

Weights (%)

US dollar

45

Deutschmark

35

UK pound sterling

10

French franc

5

Swiss franc

*National

5

Bank of Poland, 1997, Annual Report 1996, Warsaw, p. 43.

Page 57

Figure 6.3. Slovakian currency basket Table 6.3. Composition of currency basket for Slovakia, 1994–98 Currency

Weight (%)

Exchange rate

US dollar

40

31.209

Deutschmark

60

20.227

European countries, it would be possible to conduct international trade with those countries in euros. That is, for the purpose of exports and imports to these regions, goods and service could be priced in euros. · The submergence of Deutschmark and French franc into euros was due to the automatic conversion as a result of these countries being members of the new single European currency. Another example of a currency basket that has been affected by the launch of the euro is that of Slovakia. The composition of the basket over the period 1994–8 is shown in Table 6.3 and Fig. 6.3. The Malaysian currency basket is formed by five currencies, as shown in Fig. 6.4 and Table 6.4. The strategic options that were open to countries for altering the composition of the currency baskets can be summarised as follows:

Figure 6.4. Malaysian currency basket (summer 1998) Table 6.4. Malaysian currency basket, 1998 Currency

Weight (%)

US dollar

30

Japanese yen

20

Deutschmark

15

UK pound sterling

15

Singapore dollar

15

Page 58

Figure 6.5. Currency basket of Malta, (1998) Table 6.5. Currency basket of Malta, 1998 Currency

Weight (%)

UK pound sterling

13.52

US Dollar

21.32

ECU = Euro

65.16

· Scenario 1. Could have kept all the existing weights and simply substituted for the euro those currencies that have gone into EMU. · Scenario 2. Could have eliminated some of the currencies that were previously in the basket, eg, sterling and/or Swiss franc, and just have adopted the euro to represent them. · Scenario 3. Could have kept the same categories of currencies but have changed the weights (further explained below). Here the case of Malta is presented as an example of a currency basket for analysing the strategies for restructuring of a basket. In Fig. 6.5 and Table 6.5 the composition of the currency basket of the Central Bank of Malta in 1998 (ie, prior to the launch of the euro) is shown, which in effect reflected their foreign exchange reserve management. The ECU also portrayed the weight of the Maltese trade with the Italians. The options that Malta faced to restructure the currency basket were the following: · Scenario 1. The ECU could have been changed directly to the euro and all the existing weights maintained. · Scenario 2. Could have eliminated the UK pound sterling and just adopted the euro and the US dollar. · Scenario 3. Could have kept the same group of currencies but only changed the weights, eg, increased the weight of the euro from 65% to, say, 80%. 6.3— Abandonment of Currency Baskets Currency baskets are at times terminated in favour of either a complete ''free float" or a "managed float". In the case of a free float, there is no obligation on the part of the central bank to interfere,

whereas under a "managed float" the central bank interferes whenever it considers it necessary in order to maintain some degree of stability in the currency.

Page 59

Two examples of currency baskets that have abandoned are provided here. On May 27, 1997, the Czech Republic abandoned its currency basket when there was a "run" on its currency by speculators. The Czech Republic represents an example of an informal and loosely managed float referred to as a regime with a "managed float". In fact, although technically the Czech koruna is considered to be a floating currency, the Czech central bank attempts loosely to maintain the stability of the currency. It is of interest to the Czech National Bank to maintain some degree of stability towards the euro on two grounds: · first, the Czech Republic's exports are mainly directed towards the European area; and · second, the country is in line to enter the EU. Another example of abandonment of a currency basket is the case of Korea, which occurred in December 1997. 6.4— Special Drawing Rights One particular international composite currency is represented by the special drawing right (SDR). These SDRs constitute a form of assets that represents the most significant change to be introduced in the Bretton Woods system during the years 1947–71 to supplement the international reserves of gold, foreign exchange and reserve position in the International Monetary Fund (IMF). After World War II, the European reconstruction process from 1945 to 1949 was sustained by the vast US balance of payments surpluses against Europe. When the European recovery was more or less completed (around 1950), the US balance of payments turned into deficit. Until 1957 these deficits were quite small and allowed Europe and Japan to build up their international reserves. This was the period of dollar shortage. Starting in 1958 the US balance of payments deficit increased sharply and, as the US deficits persisted and rose over time, the US gold reserves declined. At the same time, since the dollar was the international reserve currency, the dollar reserves of foreign countries grew to the point at which, in the early 1960s, they began to exceed US gold reserves. Because the pillar of the Bretton Woods system was the fixed anchorage of the dollar to gold, foreign countries started to lose confidence in its convertibility into gold at a fixed price. The dollar shortage of the 1950s gave way to the dollar glut of the 1960s. In the face of large and persistent US balance of payment deficits, it became evident that a realignment of parities was necessary. However, because the dollar was the international reserve currency, the US felt that it could not devalue to correct its balance of payments deficits. To alleviate this problem and in the hope that the US would soon be able to correct the deficits, the IMF decided to create 9.5 billion of SDRs in 1967. These SDRs were distributed in three instalments in January 1970, 1971, and 1972 to member nations according to their quotas in the IMF. The creation of SDRs did not prevent further difficulties, and in 1971 the dollar convertibility was suspended (August 15, 1971) and the Bretton Woods agreement informally collapsed. From a technical point of view, SDRs are accounting entries in the books of the IMF. SDRs are not backed by gold or any other currency, but represent international reserves created by the IMF. Their values arise as a result of the agreement of member nations. SDRs can only be used in dealings

Page 60 Table 6.6. SDR valuation basket: percentage weights at the start of each five-year period 1981–5

1986–90

1991–5

1996–2000

US dollar

42

42

40

39

Deutschmark

19

19

21

21

Japanese yen

13

15

17

18

French franc

13

12

11

11

Pound sterling

13

12

11

11

Source: IMF, 1999, Special Drawing Rights: Fund Rates Users' Guide, September 5.

Table 6.7. SDR valuation basket January 1, 1999

December 31, 1998

Euro (France)

0.1239

Ffr0.813

Euro (Germany)

0.2280

DM0.446

Japanese yen

27.2000

Yen27.200

Pound sterling

0.1050

£0.105

US dollar

0.5821

US$0.582

among central banks to settle balance of payments deficits and surpluses and not in private commercial dealings. A charge of 1.5% originally (5% subsequently and now based on market rates) was applied on the amount by which a nation's holding of SDRs fell short of or exceeded the amount allocated to it. The reason for this was to put pressure on both deficit and surplus nations to correct balance of payments disequilibria. The value of one SDR was originally set equal to one dollar. Starting in 1974, the value of the SDRs was tied to a basket of currencies. Originally 16 currencies were included in the basket. In 1981 the number of currencies was five, namely the US dollar, Deutschmark, Japanese yen, French franc and pound sterling. These currencies had been selected because their respective countries had recorded the largest exports of goods and services in the five years preceding the revision of the basket. The weights assigned to the five currencies reflected the relative importance, in terms of volumes of exports of goods and services of those five countries, as well as their respective reserve positions at the IMF. Since 1981, every five years the basket has been revised, as shown in Table 6.6. Because the basket is composed and defined in terms of amounts of units (or subunits) of each currency, the daily value of the SDR in US dollar terms is computed by converting the specific amount of each currency into dollars and then summing up these values. The exchange rate used for the conversion is the noon London market exchange rate. The following table (Table 6.7) reports the valuation basket at the beginning of January 1999. After the launch of the euro, the IMF has adopted the convention of replacing the amounts of Deutschmark and French franc in the basket with their equivalent amounts in euros. The conversion euro–euro and French franc–euro were those announced by the European Council. According to an IMF report, as of February 1999, four countries, namely Latvia, Libya, Rwanda and the Seychelles,

were pegging their currencies to the SDR.

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7— Options for a Central Bank This chapter focuses on the relevant factors that constitute an "optimal" level of reserves. It also aims to shed some light on how these issues are linked to the macroeconomic considerations in any country—in particular to the conduct of monetary policy. The chapter is designed to bring out the dilemmas that can arise in policy formulation in these areas. Moreover, it examines factors that determine the worth of currency resources that can be amassed to provide ammunition to defend a particular currency in the exchange markets. 7.1— Optimality of the Level of Reserves The term optimality in this context refers to "the best level" of reserves. This entails arriving at a "level" that neither leaves a country vulnerable when a crisis strikes nor imposes a heavy burden on the economy to maintain an ''over-excessive" volume of reserves that is too costly. In this sense vulnerable implies the possibility that a government might not be able to defend itself should vast amounts of foreign exchange abruptly leave the country; this could cause devastating economic and social impacts affecting hundreds and millions of people. So what constitutes the desired level of reserves and how does one arrive at this level? In order to assess the optimal level of reserves, the following variables are generally examined: · the ratio of reserves to short-term debt (including non-resident bank deposit); and · the ratio of reserves to money supply. The second step stems from the first in the sense that as long as the motives or aims of maintaining reserves are established, then the conditions for the optimality of reserves can be specified. 7.2— Yardsticks for Measuring the Optimality of Reserves One way of assessing the optimality of reserves is to quantify the costs and benefits of holding additional reserves. Clearly if there were no costs associated with holding foreign exchange reserves (ie, if it were a free good), then there would be no limit to the holding of this asset. Therefore, the key to the determination of optimality of reserves is a clear grasp of the true costs and the benefits. 7.3— Costs of Accumulation of Reserves How are foreign reserves accumulated in the first place? That is, how does a country holding x billion of reserves who wants to increase it to y billion undertake such a task? Reserves can increase through two routes, namely: · through an inflow of foreign direct investment (FDIs) into the country; and · through the country's trade surpluses on the international side. But what if neither of these occurs, ie, the country experiences neither foreign direct investment nor trade surpluses? How does such a country

Page 62

accumulate foreign exchange reserves? In this situation one of the following can be done: · the country can convert domestic assets into foreign currency; or · the country can borrow in the international market. In the case of a country converting domestic assets into foreign currency, the calculation of the cost is as follows. First, the country would have been earning some return on its domestic assets. This return has to be assessed and quantified. Second, the country would be able to earn some interest in the foreign exchange market (in the manner explained in Chapter 5). The difference between the return foregone on domestic assets and the interest received on foreign reserves is the "nominal" cost of accumulation of reserves. For example, suppose that a country is receiving 10% return on its domestic assets (which could be, say, the yield on its domestic bonds). If the country converts these assets into a foreign currency—say into US dollars and receives 5%, then the difference in the returns of five percentage points is the cost of holding foreign reserves. It is worth adding a word of caution here. In reality, when converting domestic assets into foreign reserves the ramifications of such a conversion are usually notable. For the returns foregone on domestic assets could be far greater than those which would enter the first set of calculations. This is because any domestic investment (which in turn forms domestic assets) entails a multiplier effect that has to be incorporated into the calculation. For example, suppose that for a given resource the choice is between two alternatives, namely: · investing it in building schools in a country and improving the level of education; and · converting it to foreign currency and holding it as a foreign exchange reserve. The "return foregone on domestic assets" has to be carefully and accurately calculated to reflect the benefits foregone of, say, the investment of the resource into education and the multiplier effect over the future years of that education project. Thus, one has to conduct a "social cost-benefit analysis" and carefully assess and quantify the economic impacts as well as the economic multipliers of both the benefits and costs. The other side of the coin is the situation where the country does not hold the appropriate level of reserves and thus, as a result of its inability to defend its currency, leaves itself open to the possibility of devastating economic and social consequences that could affect millions of people. That is, due to the country's inability to prevent substantial capital outflows, the country could experience the adverse consequences of a run on its currency and suffer the devastating economic and social consequences. In the case where a country borrows in the international market, it would create new external liability and the country has to pay interest on its borrowings. The cost for this external liability would have to be assessed. At the same time, the sums that have been borrowed in order to add to the stock of foreign reserves can earn some interest in the foreign exchange market (as explained earlier in Chapter 5). In this case, therefore, the cost of reserve accumulation is the difference between the cost of borrowing the external liability (ie, interest payable on foreign loans raised for the purpose of reserve accumulation) and the returns received on foreign reserves holdings. For instance, a country can borrow dollars from the international capital market or from the International Monetary Fund (IMF) at 8%. If, say,

Page 63

the return on its holdings of dollars is 5%, then the three percentage point difference is the cost of accumulation of reserves. The loan would ultimately be repaid using domestic assets. Again, the country would have been earning some return on these assets. Thus, the returns foregone would be another component to be added to the cost. In addition to the above quantifiable cost incurred by a country, there exists an additional cost, represented by the opportunity cost of holding reserves in a liquid form. In fact, due to exchangerate policy considerations, reserves are held in a high liquid form, which in turn involves a lower rate of return. Instead of being invested in such liquid form, the resources devoted to external reserves could be invested either in domestic or international assets with longer maturity and therefore higher yields. Reserves are effectively national savings. But how does one measure such returns? There is clearly a side to the calculation of the benefits and the costs that does not enter the direct comparison of return differentials (say between short-term and long-term yields). What is the cost of a substantial drop in a currency and the ensuing crisis—followed by a massive recession, unemployment, etc.? In parallel to such a cost can be the reward of a recovery. On the other hand, one has to measure the benefit of a recovery witnessed by a speedy entry into a trade surplus as a result of the currency depreciation and the consequent job creation, export accumulation and rapid economic growth. Thus, the calculations of the cost and the benefits have to be expanded to encompass a much bigger overall picture and should include many dimensions of the consequences of a currency drop and the ensuing crisis. A much longer time period for the analysis has to be taken into account and applied in order to capture all the ramifications of a currency drop. 7.4— Monetary Policy versus Reserve Policy In general, each economic system has some inherent automatic adjustment mechanisms (the socalled automatic stabilisers) that allow the system to react and adjust to shocks and perturbations. These mechanisms can be either reinforced or offset by policy actions. Policy-makers face two options: · to let the system work out some adjustments towards a "natural" equilibrium; or · to intervene to achieve some pre-set goals and targets. When following the latter option, policy-makers are very often confronted with the dilemma of how to reconcile objectives not mutually compatible. Moreover, depending on structural and contingent factors, they engage in laborious fine-tuning processes of their policies so as to generate acceptable outcomes. The most common situation faced by a monetary authority is the conflict between domestic and international objectives. It is well known that, for instance, unless a country resorts to protectionist measures of capital and trade controls, domestic objectives such as price stability, inflation or interest-rate targets are in general in opposition to international objectives such as external price stability. If a country devotes all its efforts and resources to keeping its exchange rate fixed, the prevailing international policy-making will mostly determine its inflation target and its own interest rate. On the other hand, if a country wants entirely to focus on its domestic objectives, then it needs to insulate its economy from international shocks and/or "sterilise" the external influence

Page 64

Figure 7.1. Interaction of monetary policy with reserve policy.

by letting its exchange rate fluctuate. These extreme cases are rare. More often countries have set both domestic and international objectives and, depending on the circumstances, they have leaned more towards one or the other. Clearly, large economies have higher degrees of freedom in choosing targets and instruments, as they are able to affect (or to be less affected by) international market conditions. 7.4.1— Interaction Monetary Policy versus Reserve Policy Figure 7.1 illustrates the interaction of monetary policy with reserve policy. There are feedback effects from reserve policy to monetary policy, and vice versa. For instance, if a central bank has the statutory objective of inflation control and price stability, the conduct of this policy will require setting compatible interest rates. In the free global financial market this level of interest rate will have repercussions in terms of attracting international resources (inflows of capital). These flows of international capital will in turn have effects on the exchange rate and, depending on the exchange-rate policy, the level of reserves could be affected. Moreover, the fluctuation of the exchange rate (if a country adopts a floating regime) or the change in reserves through official interventions (if a country manages or pegs its exchange rate) will produce feedback effects on domestic conditions. In fact, an appreciation or depreciation of the exchange rate will induce adjustments of portfolio decisions, which in turn will affect interest-rate movements. In addition to these investment effects, the variation of the exchange rate will instigate a variation in the consumer price index through the changed cost of imported international goods. The nature of the interaction between monetary policy and reserve policy requires policy-makers to find the proper balance between conflicting objectives and to envisage a compromise whenever a perturbation hits the economic system. The shock could be generated domestically or internationally. In either event, the transmission mechanism and the feedbacks analysed in Fig. 7.1 between monetary policy and reserve policy are the same. When there is a big inflow of capital, one policy option open to such a country would be to engineer or bring about conditions that would stimulate an outflow of capital. In any case, any barrier to capital outflow should be removed.

Page 65

The situation of a country confronted with the problem of whether to let its currency appreciate at the cost of undermining competitiveness of its exports applies to Japan in 1999.* Japan was keen not to let the yen appreciate against the dollar. The Bank of Japan intervened by buying dollars and selling yen to prevent the yen/dollar exchange rate falling below 115. By using official interventions (increasing the level of official reserves) and cutting the domestic interest rate, a country's currency is prevented from appreciating. But such actions could be inflationary, for the following reasons: · Lowering the level of interest rate would be an expansionary measure, putting upward pressure on the domestic prices. · The additional flows of the currency due to official intervention, like that of Japan, raises the money supply, thus generating further liquidity. This rise in money supply can in turn be inflationary. Because of the historically low level of Japanese inflation rate and real interest rate, the Japanese monetary authorities have preferred to give priority to international objectives instead of domestic price control. 7.4.2— Responsibility for Managing External Assets and Liabilities The issue of controlling external assets has developed into a defining feature of modern central banking after the abandonment of guaranteed convertibility of national currencies into gold at fixed exchange rates. In the absence of an external standard of value, the key determinant of the exchange value of the money (price level) became the rate of expansion of the money itself. Governments thus became faced with the need to manage their currencies on a discretionary basis. In relation to reserve management the issue of external debt becomes relevant in as much as the country may wish to use its reserves to repay its debt ahead of the schedule. Thus, the country's priorities have to be spelled out and ranked, such as: · exchange rate stability; or · return on assets (or return on national savings). The conflict in policy between managing reserves—with its implication on external debt and exchange rates and monetary policy—is depicted in Fig. 7.2. Monetary policy where the objective is domestic price stability generally takes precedence over reserve policy. However, wherever the size of the foreign reserves has risen substantially, such as in the case of Japan, or when capital inflow into the country becomes very large, monetary policy becomes subservient to reserve policies, and exchange-rate controls and stability become the country's temporary priorities. 7.4.3— The Role of Central Banks as Intermediaries In some countries, exchange-rate control regulations give the central bank a virtual monopoly on foreign exchange operations. Exporters are required to surrender their foreign receipts to the central bank. In countries such as Canada and the UK international reserves are held on the books of the government or a governmental entity and not on the books of the central bank.

*See

also S. Yoshikuni, 1999, "The Relationship of the Yen and the Euro", Economic and Financial Review, 6, no. 1, Spring, p. 3.

Page

Page 66

Figure 7.2. Conflict in policy between managing exchange rates through reserves activities and monetary policy.

In Canada, for example, international reserves are an asset in the Government's Exchange Fund Account and are financed in the short run by a reduction on government deposits at the bank and in the long run by an increase in treasury bills outstanding. The Bank of Canada acts as an agent. Sterilisation involves action (or no action) to prevent changes in international reserves from having secondary effects on domestic monetary conditions via their influence on the cash reserves of the domestic banking system. Some central banks have a major role in external debt management. On some occasion central banks have adopted the role of a mediator for foreign resources by raising funds

Page 67

A purposeful management of the external reserves can produce profit increments for the central bank. Although liquidity and security are seen as priorities, there are many golden rules to follow regarding: · choice of currencies; · choice of investment instruments; and · observance of limit on maturity and instruments. The reserve management staff of a central bank is often expected to maximise profit by the application of a number of conventional yield-enhancing techniques and by establishing satisfactory benchmarks for reserve-asset management performance.

Page 69

8— Reserve Management from the Perspective of the EMU Region The introduction of the euro has entailed significant structural changes for the foreign reserves of the central banks of the European economic and monetary union countries and the European Central Bank. The total volume of foreign exchange reserves needed in EMU was anticipated to be much lower than under the previous exchange-rate scheme, as the exchange-rate risks within the monetary union would disappear. 8.1— Foreign Reserves of the Euro Area Following the conversion to the euro, all the currencies of the EMU members held by the central banks in the European System of Central Banks (ESCB) are no longer foreign exchange reserves, but have become euro-denominated "internal assets". Portfolio adjustments are likely to continue for some time after EMU has begun. Table 8.1 depicts the fixed conversion rate adopted by the EMU countries to convert their respective currencies, as well as their Euro-zone reserves in the new currency. It had been anticipated by the market that EMU would lower currency reserves in the ESCB probably by at least 20% and that reserve requirements would fall sharply in the medium term. Central banks were expected to change their portfolios, possibly by selling gold, raising dollar holdings and/ or exchanging currencies of the "ins". However, in the interest of stability and exchange-rate policy, a massive adjustment of the EU central banks' portfolios appeared unlikely— at least in the early stages of EMU. Some of these expectations and prophecies have been proven to be correct. As shown by Table 8.2 and Fig. 8.1, there has been a sustained decline in the foreign exchange reserves of the euro area of about 17.7% during the first six months of euro's life. It is interesting to examine the aggregate volume of reserves of the 11 central banks of the EU during the 1990s. At the time when the exchange-rate mechanism (ERM) system was put under stress, the total reserves declined so as to sustain those currencies under attack. During the period 1990–3 numerous interventions attempted to avoid realignments of central parities. Several central banks intervened by selling their reserves in Deutschmarks (the strong currency) and by buying their own currency to sustain the status quo. Because the ERM mechanism was based on the principle of bilateral Table 8.1. The irrevocable conversion rates against the euro adopted by the participating member countries of the Euro-zone Country

Fixed euro conversion rate

Austria

Sch13.7603

Belgium/Luxembourg

Bfr/Lfr40.3399

Finland

FM5.94573

France

Ffr6.55957

Germany

DM1.95583

Ireland

I£0.787564

Italy

L1936.27

Netherlands

Fls2.20371

Portugal

Esc200.482

Spain

Pta166.386

Source: European Central Bank.

Page 70 Table 8.2. Foreign exchange reserves of euro area Year

SDRs (millions)

SDRs per US dollar (end of period)

US dollars (billions)

1991

185,458

0.69909

265.3

1992

182,278

0.72727

250.6

1993

173,098

0.72804

237.8

1994

177,121

0.685

258.6

1995

176,787

0.67273

262.8

1996

201,350

0.69543

289.5

1997

222,432

0.74115

300.1

1998—II

224,369

0.75101

298.8

1998—III

219,175

0.72922

300.6

1998—IV

189,796

0.71021

267.2

1999—February

168,229

0.7323

229.7

1999—March

169,877

0.73646

230.7

1999—April

165,973

0.74007

224.3

1999—May

163,777

0.74358

220.3

1999—june

164,614

0.74857

219.9

Source: IMF, 1999, International Financial Statistics, LII, no. 8, August. SDRs, special drawing rights.

Figure 8.1. Foreign exchange reserves of euro area Source: IMF, 1999, International Financial Statistics, LII, no. 8, August.

intervention, the Bundesbank was at the same time selling Deutschmarks and buying the currencies under attack. The final effect, however, was the following:

· The depletion of reserves in Deutschmarks experienced by several central banks offset the increase in reserves experienced by the Bundesbank (shown in Fig. 8.1), so that the aggregate of reserves of the euro area fell during the first three years of the 1990s. · Because of the speculative activities and the fall in reserves, some central banks decided to abandon the system (ie, the UK and Italy), whereas, leaving aside few exceptions, the band of admissible fluctuation of the exchange rate was widened from plus or minus 2.5% around the central parity to 12% each side of the central parity. This increment of the band was meant to reduce the need for central bank interventions. Instead, it created a de facto floating exchange-rate system. For a short time following the ERM crisis of 1993, the level of the foreign exchange reserves of the euro area was rather stable. The reserves started to

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Page 71

increase in 1995 and, by 1997, they had reached their maximum level of the decade. Subsequently, they kept at a very steady level until the launch of the euro, before beginning to decline. As of end of June 1999 the reserves had dropped to their minimum level in the 1990s. The behaviour of the reserves of the 11 EMU countries during the 1990s has not been homogeneous. The total foreign exchange reserves of the euro combines different experiences, and shows only the main tendencies of the aggregate of the 11 countries. More detailed information is provided for each country in Section 8.3 of this chapter. Before moving to that section, one should consider the reserve position of the newly established European Central Bank. 8.2— Official Reserves of the European Central Bank For the formation of the European Central Bank the participating national banks have transferred to the ECB currency reserves and gold with a counter-value of close to 40 billion euros. The composition of the reserves of the ECB is shown in Fig. 8.2.

Figure 8.2. Official reserves of the Central European Bank.

The fully paid-up subscriptions of the National Central Banks of the EMU zone to the capital of the ECB is 3,946,895,000 euros. The share of each central bank is depicted in Table 8.3a. Table 8.3b shows the share for each central bank had all 15 countries joined the European

Page 72 Table 8.4. Foreign exchange reserves of the EU countries at the end of 1996 as percentage of GDP Country

Percentage of GDP

France

3.7

UK

4.0

Germany

5.0

Italy

5.8

Finland

6.1

Belgium and Luxembourg

8.0

Sweden

8.3

Denmark

8.5

Netherlands

10.1

Spain

11.0

Austria

11.7

Ireland

12.4

Greece

15.3

Portugal

20.4

EU

6.3

Japan

4.9

Table 8.5. Composition of reserves of the ECB Currency

Weights (%)

US dollars

90

Japanese yen

10

Figure 8.2 and Table 8.5 portray the composition of the official reserves of the ECB. Of the 85% foreign exchange holding, the ECB has opted to hold 90% of its foreign currencies in US dollars and 10% in yen. The question is asked, what is the social cost of holding large reserves? Could some of these reserves not be used to reduce unemployment in Europe? Also, could it not be used for debt reduction in Europe? Here the question arises as to whether Europe will be better off with, say, x billion dollars of its reserves spent on youth training schemes as opposed to keeping it in a central bank. If the euro arrives to challenge the role of the mighty dollar as international reserve currency, a lower level of foreign exchange reserves for the ECB will be required. When a currency holds the status of an international currency, it has some benefits, but also it suffers from some drawbacks; these include the following: · The central bank that manages the particular reserve currency cannot limit monetary policy to its own country, but also has to take account of the problems of other regions. For example, when the US Federal Reserve Board reduced its interest rate during autumn 1998, part of the reason for the

rate cut was to alleviate some of the problems of the South-East Asian crisis. The healthy state of the US economy was subsequently reflected in the US employment data revealed in December 1998. · Being a reserve currency makes the system conducive to over-borrowing because there is a ready demand for the currency and there is a risk of mounting debt. Finally, it is worth stressing that the structural changes that will be inevitable with the establishment of the euro cannot be ignored. It cannot be assumed that the economic variables will perform as before and the same pattern will continue. The euro in the medium term will bring about major structural changes globally.

Page 73

Figure 8.3. Foreign exchange reserves of Austria Source: IMF, 1999, International Financial Statistics, LII, no. 8, August.

8.3— Official Reserves of the European System of Central Banks (ESCB) The path followed by the foreign exchange reserves of the 11 countries forming the EMU during the decade of the 1990s is presented here.* Two main events have shaped the patterns of the reserves of the European countries: first, the intense speculative activities at the beginning of the decade; and second, the preparation for the advent of the EMU at the end of the decade. The former event is related to the aftermath of German unification. The five years that followed that event have witnessed several episodes of speculative attack against some currencies of the ERM, because of the view that central parities would be realigned. In particular, countries such as Italy, Spain and France have undergone heavy losses of their official reserves. After the realignment and the widening of the bands that signalled a de facto failure of the target-zones system of the ERM, countries started to replenish their reserves of foreign currencies. Some countries had a different experience, for instance Austria, which at the time of the crisis was not part of the ERM. The second feature of the 1990s is linked to the final phase of the preparation for EMU, which has required the 11 countries to merge part of their holdings. Figure 8.3 depicts the situation of Austria's foreign reserves. The path followed by Austrian reserves is, to some extent, peculiar, as the country has a shorter history of membership in the ERM. The volume of foreign reserves increased steadily until the year 1996, and after that date, it has decreased, with a substantial drop in 1999. As for the other 10 countries of EMU, the year 1999 has called for a dramatic drop of reserves. There are two reasons for this. One of these is the accounting operation of shifting international assets into domestic assets in the 11 central banks' balance sheets. The second reason is not linked to an accounting concept, but rather is due to the real outflows of reserves towards the ECB. National central banks have still retained part of their reserves but, clearly, they cannot be used for any monetary policy operations. Portugal offers another case of a peculiar path of foreign reserves. In contrast with almost all the rest of Europe, the country has maintained a very stable level of foreign reserves from the year 1993 until the inception of the euro. The Portuguese situation is portrayed in Fig. 8.4. *W.

F. Duisenberg, 1997, ''The European System of Central Banks: A Profile", Economic and Financial Review, 4, no. 4, Winter, p. 161; J. Godeffroy, 1999, "Collateral Management in the Eurozone: the European Central Bank's View", Economic and Financial Review, 6, no. 2, Summer, p. 87.

Page

Page 74

Figure 8.4. Foreign exchange reserves of Portugal Source: IMF, 1999, International Financial Statistics, LII, no. 8, August.

Page

Page 75

Figure 8.7. Foreign exchange reserves of Italy Source: IMF, 1999, International Financial Statistics, LII, no. 8, August.

Page 76

Figure 8.9. Foreign exchange reserves of Luxembourg Source: IMF, 1999, International Financial Statistics, LII, no. 8, August.

Figure 8.10. Foreign exchange reserves of Netherlands Source: IMF, 1999, International Financial Statistics, LII, no. 8, August.

Figure 8.11. Foreign exchange reserves of Finland Source: IMF, 1999, International Financial Statistics, LII, no. 8, August.

Page 77

Figure 8.12. Foreign exchange reserves of Ireland Source: IMF, 1999, International Financial Statistics, LII, no. 8, August.

Although Luxembourg and the Netherlands present dissimilar paths of foreign reserves before the ERM crisis of 1993, they share the same sort of long-run tendency after that date (Figs. 8.9 and 8.10). In particular, for both countries the decline in reserves occurred well before the launch of the euro and at a very rapid pace. The decline is impressive, especially in the case of Luxembourg, which in less than two years reduced its holdings of foreign reserves to zero. The cases of Finland and Ireland (Figs. 8.11 and 8.12) are similar in the following respect: unlike the other European countries, the reserves of Finland and Ireland have gone through several phases of ups and downs before the drop in 1999.

Page 79

9— Reserve Management from the Perspective of the Non-EMU Region In this chapter we focus on tracing the role of the euro in the reserve management of countries that are not members of the European economic and monetary union (EMU). The evolution of the euro as a currency is significant and has important implications—not just for those within the European Union, but also for the rest of the world.* Until shortly before the start of EMU, in most of the non-European countries there was an attitude of total indifference towards the birth of the euro. In the years running up to the euro most countries, both within and outside Europe, thought that EMU would commence with only six countries. * Thus, when in May 1998 the European Council approved the participation of 11 countries, the nonEMU world woke up to the reality of the disappearance of some 11 currencies of countries with which they could have had trading relationships. The question of sustainability of the EMU in Europe still looms large at the back of sceptical minds. The 17% drop experienced by the euro in its first year of its infancy was not conducive to the creation of credibility. The euro was launched with a starting value of one euro equivalent to US$1.17 in January 1999, and reached a low of around one euro equivalent to US$1.02 by the following summer of 1999 and reached parity by December 1999. It is worth noting that the euro was launched against a backdrop of economic recession in Europe. The economic cycle was in its downturn and, with unemployment high and growth of the Euro-zone negligible, there was little confidence in the economy of "Euroland". The "non-EMU region" embraces all regions of the world except the Euro-zone. This chapter is designed to bring out the role and impact of the euro on reserve management from the perspective of those countries lying outside the boundaries of the European single currency. To understand the possible implications that can unfold with the euro, it is useful to gain a fuller view of the developments of reserves of the non-EMU countries across the world that occurred in the past decade, focusing in particular on the years immediately before and after the launch of the new currency. The establishment of EMU undoubtedly has far-reaching consequences for the management of reserves of the non-EMU zone in the long run. However, in the first year of EMU the adoption of the euro as an international currency has been rather slow and is likely to continue at a moderate pace. The European Central Bank takes a neutral stance on this issue and considers it a question that is purely for the non-EMU countries to consider. At the very practical level the application of the European single currency as an instrument for financial transactions (ie, for international receipts and payments) will bring about its further use as a reserve currency, and hence as a reserve asset. According to a projection made by the International Monetary Fund (IMF) in 1997 prior to the launch of the euro, the percentage of the European single currency in relation to other currencies used for receipts and payments should be around 20% on a global scale. However, up to the emergence of the European single currency, the proportion of the *C.

Noyer, 1998, "The Euro in the Global Financial Market", Economic and Financial Review, 5, no. 4, Winter, p. 167. *See

also H.M. Scobie, 1997, "Implications of EMU for the Global Emerging Markets", Economic and Financial Review, 4, no. 3, Autumn, p. 141.

Page 80

Deutschmark in reserves stood at approximately 17%. This was half of what it "ought" to have been on fundamental grounds—based on the principles of risk and return. 9.1— Starting Value of the Euro against other Currencies The starting value of the euro against other non-EMU currencies is shown in Tables 9.1 and 9.2. Table 9.1 shows the starting value of the euro against the leading hard currencies, ie, those that have been used by other central banks as a reserve currency. Table 9.2 shows the starting value of the euro against some of the other non-EMU currencies. To ascertain the impact of the euro on reserve management, it is useful to look at some examples of foreign exchange reserve composition within some of the existing central banks in different parts of the world. The euro's performance since its launch has clearly affected the speed and pattern of the reserve portfolio adjustments of countries across the Table 9.1. Starting value of the euro against leading currencies as of January 4, 1999 Country

Conversion rate to euro

US

$1.1743

Japan

Y132.4554

UK

£0.7058

Switzerland

Sfrl.6129

Table 9.2. Starting value of the euro against other currencies as of January 4, 1999 Country

Ecu rate

Country

Ecu rate

Argentina

Ps 1.1732

New Zealand

NZ $2.2229

Australia

A$ 1.9145

Philippines

Ps45.6784

Brazil

R$:1.418

Poland

Z4.1217

Canada

C$ 1.8037

Romarnia

lei 12916.7750

Cyprus

C£ 0.5824

Russia

Rbs 25.3053

Czech Republic

Kc 35.2639

Saudi Arabia

SR4.4046

Denmark

Dkr l7.4735

Sweden

SKr 9.5183

Estonia

Ekr 15.6631

Singapore

S$ 1.9375

Greece

Dr 328.8488

Slovakia

Ks 43.2418

Hong Kong

HK$ 9.0973

Slovenia

Tolar 190.0230

Hungary

Ft 252.8102

South Africa

R6.9079

Indonesia

Rp 9335.3000

Thailand

Bt 42.6664

Israel

Shk 4.8850

Taiwan

T$ 37.8314

Korea

Won142.0363

Turkey

TL370358.5125

Malaysia

M $6.3762

UAE

Dh 4.3129

Mexico

Ps 14463.2960

Special drawing

SDR0.8321

Norway

Nkr 8.9467

right

Figure 9.1. The performance of the euro against the US dollar

Page

Page 80

Deutschmark in reserves stood at approximately 17%. This was half of what it "ought" to have been on fundamental grounds—based on the principles of risk and return. 9.1— Starting Value of the Euro against other Currencies The starting value of the euro against other non-EMU currencies is shown in Tables 9.1 and 9.2. Table 9.1 shows the starting value of the euro against the leading hard currencies, ie, those that have been used by other central banks as a reserve currency. Table 9.2 shows the starting value of the euro against some of the other non-EMU currencies. To ascertain the impact of the euro on reserve management, it is useful to look at some examples of foreign exchange reserve composition within some of the existing central banks in different parts of the world. The euro's performance since its launch has clearly affected the speed and pattern of the reserve portfolio adjustments of countries across the Table 9.1. Starting value of the euro against leading currencies as of January 4, 1999 Country

Conversion rate to euro

US

$1.1743

Japan

Y132.4554

UK

£0.7058

Switzerland

Sfrl.6129

Table 9.2. Starting value of the euro against other currencies as of January 4, 1999

Page

Page 80

Deutschmark in reserves stood at approximately 17%. This was half of what it "ought" to have been on fundamental grounds—based on the principles of risk and return. 9.1— Starting Value of the Euro against other Currencies The starting value of the euro against other non-EMU currencies is shown in Tables 9.1 and 9.2. Table 9.1 shows the starting value of the euro against the leading hard currencies, ie, those that have been used by other central banks as a reserve currency. Table 9.2 shows the starting value of the euro against some of the other non-EMU currencies. To ascertain the impact of the euro on reserve management, it is useful to look at some examples of foreign exchange reserve composition within some of the existing central banks in different parts of the world. The euro's performance since its launch has clearly affected the speed and pattern of the reserve portfolio adjustments of countries across the Table 9.1. Starting value of the euro against leading currencies as of January 4, 1999 Country

Conversion rate to euro

US

$1.1743

Japan

Y132.4554

UK

£0.7058

Switzerland

Sfrl.6129

Table 9.2. Starting value of the euro against other currencies as of January 4, 1999

Page 83 Table 9.3. Foreign exchange reserves of Japan Year

SDRs (millions)

SDRs per US dollar (end of period)

US dollars (billions)

1991

43,174

0.69909

61.8

1992

45,009

0.72727

61.9

1993

64, 591

0.72804

88.7

1994

78,875

0.685

115.1

1995

116,007

0.67273

172.4

1996

144,187

0.69543

207.3

1997

154,060

0.74115

207.9

1998—II

144,842

0.75101

192.9

1988—III

144,787

0.72922

198.6

1988—IV

144,326

0.71021

203.2

1999—February

154,503

0.7323

211.0

1999—March

155,691

0.73646

211.4

1999—April

156,289

0.74007

211.2

1996—May

157,747

0.74358

212.1

1999—June

176,216

0.74857

235.4

Source: IMF, 1999, International Financial Statistics, LII, no. 8, August.

Figure 9.5. Foreign exchange reserves of Japan Source: IMF (1999), International Financial Statistics, LII, no. 8, August.

the yen would also create a real opportunity to channel the large pool of Japanese domestic savings and make them available to satisfy the financial needs of other countries. Thus, the launch of the euro is perceived as a real challenge for Japanese monetary authorities. Its success is viewed as an event that should prompt the Japanese authorities to eliminate all existing obstacles to the international use of the yen, and to promote more actively its desirability as an

international currency. UK The case of the UK is particularly interesting as the country is not part of EMU, but has full membership within the European Union.* This particular status, shared by the UK with three other countries (Greece, Denmark and Sweden), has considerable implications for UK foreign reserve management. In fact, in so far as the UK is a member of the custom union area, its main *See

also Q. Davies, 1996, "The United Kingdom and Europe", Economic and Financial Review, 2, no. 2, Summer, p. 69.

Page

Page

Page 85 Table 9.6. Foreign exchange reserves of the UK Year

SDRs (millions)

SDRs per US dollar (end of period)

1990

US dollars (billions)

0.70291

0.0

1991

27,074

0.69909

38.7

1992

24,791

0.72727

34.1

1993

25,210

0.72804

34.6

1994

26,392

0.68500

38.5

1995

26,357

0.67273

39.2

1996

25,816

0.69543

37.1

1997

21,403

0.74115

28.9

1998—II

20,584

0.75101

27.4

1998—III

20,832

0.72922

28.6

1998—IV

19,434

0.71021

27.4

1999—February

17,483

0.73230

23.9

1999—March

17,389

0.73646

23.6

1999—April

17,563

0.74007

23.7

1999—May

0.74358

0.0

1999—June

0.74857

0.0

Source: IMF, 1999, International Financial Statistics, LII, no. 8, August.

Page 86 Table 9.7. Foreign exchange reserves of United States Year

SDRs (millions)

SDRs per US dollar (end of period)

US dollars (billions)

1991

32,112

0.69909

45.9

1992

29,095

0.72727

40.0

1993

30,237

0.72804

41.5

1994

28,233

0.685

41.2

1995

33,028

0.67273

49.1

1996

26,631

0.69543

38.3

1997

22,834

0.74115

30.8

1998—II

23,408

0.75101

31.2

1998—III

23,978

0.72922

32.9

1998—IV

25,568

0.71021

36.0

1999—Feb

22,348

0.7323

30.5

1999—Mar

22,386

0.73646

30.4

1999—Apr

22,170

0.74007

30.0

1999—May

22,009

0.74358

29.6

1999—Jun

22,055

0.74857

29.5

Source: IMF (1999) Internationl Financial Statistics, Vol. LII, No.8 August

Figure 9.7. Foreign exchange reserves of United States Source: IMF (1999), International Financial Statistics, LII, no. 8 August.

USA Figure 9.7 and Table 9.7 portray the evolution of the US reserves. As already stressed in previous chapters of this book, after 1995 the US has shown a clear tendency to reduce its holdings of reserves, which have reached levels well below those of the beginning of the 1990s.*

9.2.2— The Other Countries China China is the country with the second largest volume of foreign reserves in the world. As of the end of May 1999, the share of Chinese foreign reserves amounted to 24.5% of the foreign reserves of Asia, 9.5% of the total reserves of the world, and 15.1% of the total reserves of the developing countries. *See

also L. Lindsey, 1996, ''On Sovereign Risk", Economic and Financial Review, 3, no. 3, Autumn, p. 101.

Page 87

As shown in Table 1.2 and in Fig. 1.3 in Chapter 1, after 1993 and until 1997 China's foreign reserves increased at an impressive pace. The average annual rate of increase during that period was about 140%. China's foreign exchange reserves by the end of June 1999 were worth around US$147 billion. Until the European single currency has matured, the bulk of these will be maintained in dollars. Czech Republic Table 9.8 portrays the composition of the foreign reserves of the Czech National Bank as of Autumn 1998. The Czech Republic was linked to a currency basket, but abandoned it on May 27, 1997, at a time when the country was in financial crisis. Table 9.8. Position of foreign reserve holdings of the Czech National Bank as of Autumn 1998 Currency

Weights (%)

Deutschmark

65

US dollar

35

Figure 9.8. Position of foreign reserve holdings of the Czech National Bank as of autumn 1998

Hong Kong As already pointed out in Chapter 5, the foreign exchange reserves of Hong Kong are held by the Exchange Fund, but they are managed by the Hong Kong Monetary Authority (HKMA). In terms of volume, Hong Kong has the fourth largest amount of reserves in the world, after Japan, the Mainland of China, and Taiwan. In 1999, in response to the repercussions of the Asian financial turmoil on the Hong Kong dollar, HKMA undertook several reforms and new strategies. One important change adopted by the Exchange Fund was the longterm allocation strategy for the management of foreign reserves. The currency composition of the Exchange Fund's assets in Hong Kong dollars at the end of December 1998, prior to the reforms, is depicted in Table 9.9. The bulk of reserves is held in US dollars. According to the new investment strategy, 80% of the Exchange Fund's foreign reserves–70% prior the launch of the reform–is to be held in US dollars. This more prudent Table 9.9. Currency composition of the Exchange Fund's foreign assets, December 31, 1998 Hong Kong dollors (billions)

%

US dollar

569. 5

81.2

European currencies

103.7

14.8

23.9

3.4

4.0

0.6

701.1

100.0

Japanese yen Others Total Source: Hong Kong Monetary Authority, Annual Repot, 1998.

Page 88

Figure 9.10. Foreign exchange reserves of Hong Kong Source: IMF (1999), International Financial Statistics, LII, no. 8 August. Table 9.10. Foreign exchange reserves of Hong Kong Year

Millions of SDRs

SDRs per US dollar (end of period)

Billions of US dollars

1991

20,139

0.69909

28.8

1992

25,581

0.72727

35.2

1993

31,295

0.72804

43.0

1994

33,737

0.68500

49.3

1995

37,268

0.67273

55.4

1996

44,374

0.69543

63.8

1997

68,782

0.74115

92.8

1998—II

72,460

0.75101

96.5

1998—III

64,444

0.72922

88.4

1998- IV

63,636

0.71021

89.6

1999- February

65,714

0.73230

89.7

1999—March

65,919

0.73646

89.5

1999—April

66,232

0.74007

89.5

1999—May

66,085

0.74358

88.9

Source: IMF, 1999, Internationl Financial Statistics, LII. no. 8, August.

management strategy reflects the determination of the HKMA to keep the value of the Hong Kong dollar stable while enhancing the credibility of the currency board system. The evolution of Hong Kong foreign reserves is shown in Fig. 9.9 and Table 9.10. Hong Kong's reserves have increased at a very steady and rapid pace. At the end of 1997 reserves had increased by 220% with respect to 1991. The year 1998 was a difficult one for Hong Kong because of the several episodes of speculative attacks against the Hong Kong dollar and the deepest economic contraction in 40 years experienced by the Hong Kong economy.

Korea The composition of Korean foreign reserves as of Autumn 1998 is shown in Fig. 9.10 and Table 9.11. As in previous examples, the bulk of the reserves are held in US dollars. The development of Korean reserves has already been discussed in Chapter 1. As depicted in Fig 1.1 in Chapter 1 and reported here in Table 9.12, the foreign reserves show a steep upward trend after the financial meltdown of 1997. The monetary authorities feel that through a heavy build-up of reserves they will be able to provide better liquidity for the market should a crisis strike. The ability to inject liquidity into the market would in turn

Page 89

Figure 9.11. Position of foreign reserve holdings of the Bank of Korea as of autumn 1998 Table 9.11. Position of foreign reserve holdings of Bank of Korea as of Autumn 1998 Currency

Weights (%)

US dollar

75

European currencies

15

Japanese yen, Australian dollar and SDRs

10

Table 9.12. Foreign exchange reserves of Korea Year

Millions of SDRs

SDRs per US dollar (end of period)

Billions of US dollars

1991

9,302

0.69909

13.3

1992

12,102

0.72727

16.6

1993

14,345

0.72804

19.7

1994

17,147

0.685

25.0

1995

21,479

0.67273

31.9

1996

23,114

0.69543

33.2

1997

14,608

0.74115

19.7

1998—II

30,614

0.75101

40.8

1998—III

34,204

0.72922

46.9

1998—IV

36,905

0.71021

52.0

1999—February

40,344

0.7323

55.1

1999—March

42,044

0.73646

57.1

1999—April

43,592

0.74007

58.9

1999—May

45,397

0.74358

61.1

Source: IMF, 1999, International Financial Statistics, LII, no. 8 August.

provide the necessary ammunition to stabilise the market at times of unforeseen reversals of capital flows. Similarly to the Czech Republic, Korea also had its currency pegged to a currency basket. The system was abandoned on December 16, 1997.

Switzerland The foreign exchange reserves of Switzerland have increased progressively at a slow pace during the 1990s. During the period 1993–8 the average annual

Figure 9.11 Foreign exchange reserves of Switzerland Source: IMF (1999), International Financial Statistics, LII, no. 8, August.

Page 90 Table 9.13. Foreign exchange reserves of Switzerland Year

SDRs per US dollar (end of period) US dollars (billions)

SDRs (million)

1990

0.70291

0.0

1991

20,275

0.69909

29.0

1992

23,593

0.72727

32.4

1993

23,042

0.72804

31.6

1994

22,985

0.68500

33.6

1995

23,333

0.67273

34.7

1996

25,574

0.69543

36.8

1997

27,384

0.74115

36.9

1998—II

24,168

0.75101

32.2

1998—III

23,759

0.72922

32.6

1998—IV

27,234

0.71021

38.3

1999—February

25,192

0.73230

34.4

1999—March

24,962

0.73646

33.9

1999 -April

24,829

0.74007

33.5

1999—May

24,143

0.74358

32.5

Source: IMF, 1999, Internatonal Financial Statistics, LII, no. 8, August.

rate of growth of Swiss reserves has been around 4.24%. The movement in Switzerland's foreign exchange reserves is shown in Fig. 9.11 and Table 9.13. 9.3— Dollarisation The term "dollarisation" is applied loosely and has different connotations. In this section an attempt is made to examine the implication and use of this terminology in various contexts. Dollarisation comes into existence when non-domestic legal tender is used by the citizens of a given country. This usage can be in one of two forms: · usage of a non-domestic legal tender side-by-side the domestic currency; and · full substitution of a domestic currency in favour of a non-domestic currency. A further classification would be to categorise the first scenario above as "unofficial dollarisation" and the second as "official dollarisation". Under the unofficial scenario residents hold bank accounts in the non-domestic currency in order to safeguard against fluctuations in the value of the national currency. This is a parallel use of domestic and foreign currency with "unofficial dollarisation''. Such a practice is very common within most emerging markets, particularly within South America. Indeed, the idea has been prevalent in many regions for decades under the second scenario of "official dollarisation", whereby the state authorises the formal acceptance of a non-domestic currency for common usage and the country's legal tender. "Official dollarisation" would occur when a country decides to forego its monetary sovereignty in preference for an external monetary

authority that is deemed more credible than its own. Following the financial meltdown that occurred in different countries during 1997/98, the attractiveness of dollarisation has gained momentum. The devaluation of the Brazilian currency, the real, which also had adverse consequences for Argentina and other South American countries, attracted more attention to the issue of dollarisation.

Page 91

10— Some Policy Prescriptions and Future Scenarios: A Global Single Currency The Content of this Chapter is Solely the Work of Professor H.M. Scobie. Would it not be desirable to eliminate the vagaries of the financial market from overturning the real economy? Phrased differently, would not so much of the anxiety of policy-makers vis-à-vis the stability of foreign exchange and its handling disappear if the world as an entity had only one currency? Is this not the inevitable direction in which the world would go? This chapter explores whether the benefits that have persuaded 11 sovereign nations in Europe to give up their currency and join the euro could be extended to apply in a different form to the global economy as a whole adopting a single currency. The fact that 11 countries in the European Union* have adopted a single currency begs the question: what would be the next stage? · All 15 countries of the EU adopt the single currency.* · With the enlargement of the EU and the addition of the first five countries that are candidates for early entry, the enlarged Union could have some 20 member countries by say between 2005 and 2010 at the latest. · With this further enlargement and an additional eight countries joining the EU, one could easily envisage a Euro-zone with 28 member countries. Figure 10.1 provides an overview of a possible course that enlargement of the EU could take. With respect to joining the euro, it is worth pointing out that, based upon the criteria of the Maastricht Treaty, any member country of the EU wishing to join the European single currency has to be a member of the ERM (Exchange Rate Mechanism) for a period of at least two years. Accordingly, any new country that joins the EU has first to join the ERM II (which is the Exchange Rate Mechanism after the euro began) and the country would have to remain within it for a period of at least two years before joining the single currency.

Figure 10.1. Possible stages of enlargement of the EU and future membership of EMU * See also M Gudmundsson, 1998, "The Implications of EMU for EFTA-Countries", Economic and Financial Review, 5, no. 1, Spring, p. 35. *See

also J. Dehaene, 1998, "Management of Economic Policies in the Eurozone", Economic and Financial

Review, 5, no. 4, Winter, p. 157. *See

E. Åsbrink, 1998, "Sweden and EMU", Economic and Financial Review, 5, no. 3, p. 127; C. Marshall, 1998, "Euro Entry into the UK led by British Industry", Economic and Financial Review, 5, no. 3, Autumn, p. 137; T.N. Christensen and M. Pedersen, 1999, "Economic Portrait of the Euro Area", Danmarks National Bank Monetary Review, pp. 1–8.

Page 92

10.1— Alternative Scenario for EU Enlargement Figure 10.1 is, nevertheless, only one scenario for the possible stages of enlargement of the EU and future membership of the Euro-zone.* It is possible that some of the Central and East European countries in line for joining the EU could adopt the single currency earlier than some of the "out" countries who are already members of the EU. In other words, it could be possible that countries such as Poland or Hungary, who were not members of the EU when the single currency commenced, could adopt the European single currency (the euro) ahead of some of the existing member countries such as the UK. There could even come a time by 2015 or 2020 when as many as 30 countries would be members of the euro, and the world economy could become polarised between three major currencies, the euro bloc, the yen bloc and the dollar bloc. 10.2— Attractiveness of the Dollar for Emerging Markets The idea of a currency union for the South-East Asian countries has already been put forward. During 1998 at one of the ASEAN conferences the idea of a single currency for that region was propounded. However, this proposition did not advance for several reasons. A currency union among the developing nations seems less desirable from their perspective and, hence, less likely. What has traditionally been more attractive to these countries has been a link to a strong currency such as the dollar. Thus, the logical extension of that would be the adoption of the dollar in place of their own currency. This is observed among the countries within emerging markets. In other words, "linking" to yet another weak currency does not have the same appeal and attraction as a " tie" to or the adoption of an internationally strong currency. Thus, monetary union within a group of developing nations becomes a non-starter. However, adoption of a currency such as the dollar is a possibility. Accordingly, this form of monetary union (through the adoption of the dollar) has been considered by some countries of South America, eg, Argentina. Would it still be a viable proposition to have fluctuating currencies–even with three currencies? It is interesting that the currencies of the countries of South-East Asia are linked more closely to the dollar than to the yen. Indeed, it is the weight and size of the US economy that gives the dollar its prominence. The yen has a small role in the global economy and Japan has done little to promote the yen as an international currency. Thus, a "yen bloc" as a form of currency union seems unlikely. 10.3— Conduct of Monetary Policy with a Reserve Currency In practice there are some conflicting influences over the management of a monetary policy and the promotion of a currency such as the yen or the "former" Deutschmark as a global reserve currency. If a country promotes its currency internationally to become a reserve currency, the value of that currency could appreciate against other currencies. This could in turn be counter-productive as far as the value of exports of the two regions are concerned. This puts indirect pressure on the interest rate of the country—requiring it to be reduced. However, a decrease in the rate of interest could in turn have an inflationary impact on the economy. For these reasons countries whose currencies could become an international reserve currency are not keen to promote them internationally. It complicates and exerts added pressure on the management of the domestic monetary policy.

*J.

Nemenyi, 1999, "Challenges of Monetary Policy in the Run-up to European Union Accession", Economic and Financial Review, 6, no. 1, Spring, p. 13.

Page 93

10.4— Adoption of One International Currency Taking the argument of the progression of currency elimination further forward, one can easily envisage a point in time—distant as it may be—when the global economy could be left with only two currencies, the euro and the dollar. The question then becomes the choice between the two currencies. The options that could then be open to the policy-makers can be summarised under some future scenarios that could emerge: · either abandon both the dollar and the euro and introduce a third currency that could be politically acceptable to both economic blocs; or · adopt one of the prevailing currencies, ie, either the dollar or the euro, and abandon the other. As explained in Chapter 9, for many of the emerging markets the adoption of the dollar, ie, "dollarisation", officially or unofficially, is already a reality. On an unofficial basis "dollarisation" is common among most developing countries. On an official basis countries such as Argentina have applied to adopt it. Needless to say, the dollar is likely to continue to have a far higher credibility than the euro. It has been established much longer than the euro. Thus, rather than introducing a new common currency and abandoning the other existing two, it could be far easier to abandon the euro and adopt the dollar. Half the globe is already familiar with the value and the workings of the dollar so no education process would be needed for it. This is unlike the case of the euro, where a very lengthy period of three years has been set aside for the transition in order to familiarise the public with the concept and conversion to the euro. It has been argued that over three years of transition are needed for the euro to allow for notes and coins to be produced in this currency! However, this period of time is far in excess of what is required in practice in order to print notes and coins. There were political factors behind this prolonged transition period—mainly propounded by some members—although it was approved by all the member countries. 10.5— Cost-Saving Elements of a Global Single Currency The real issue is the extent of the economic cost, as well as the social pain, that can be saved by developing countries or semi-industrialised countries through adoption of a global unified currency. For example, how far could the financial crises of South-East Asia, Latin America and Eastern Europe during the period 1997–8 have been averted had there been a global single currency? If they had all had the same currency, then they could have avoided the speculative attacks that caused them much economic hardship, which in turn brought about much social unrest. In parallel with the argument for the single currency comes the argument for sovereignty and the desirability for each country to have independence to manage its own currency. The latter is to some extent a fallacy on the following grounds: · it is a delusion on the grounds that in today's world there exists a strong global interdependency and complete "sovereignty" does not exist; and · it is also an illusion on the grounds that if "independence of a given country with respect to its currency" is a major issue, then the price of such an independence has to be judged against the costs involved.

The chances are that for political reasons a compromise between the euro and the dollar could result in another currency other than the dollar or

Page 94

euro. Before the launch of the euro many arguments were put forward in favour of simply adopting the Deutschmark instead of launching a new currency. However, in the final analysis it was politically more acceptable to launch a new currency. 10.6— Benefits of a Global Single Currency So what are the benefits of the proposed global single currency? The ultimate benefit is the avoidance of crises like those that had to be endured during 1997–8 by the countries of South-East Asia, Latin America and Eastern Europe. The extent of the economic hardship imposed upon the countries of these regions over the period of two years following their financial meltdown would give an indication of the cost of these crises. Avoidance of these costs would be the benefit of a global single currency. On the benefit side, the most significant advantage of a global single currency would be to prevent a collapse of some countries' currencies, eg, like that of Korea's, which was devalued by some 60% during the period October to December 1997. Table 10.1 provides only a few examples of the financial crises that erupted during the 1990s within emerging markets: Table 10.2 provides some examples of the financial crises that were experienced within industrialised countries in the 1990s. Table 10.1. Some of the financial crises experienced in the 1990s within emerging markets Country

Date

Mexico

1993

Thailand

May 1997

Czech Republic

May 1997

Korea

October/December 1997

Indonesia

October/December 1997

Malaysia

October/December 1997

Philippines

October/December 1997

Russia

August 1998

Hong Kong

August/October 1998

Brazil

February 1999

Table 10.2. Some examples of sizeable interventions within industrialised countries Date

Countries UK & Italy

September 1992

US (Federal Reserve & Treasury)

June 1993

Japan

May 1999 (buying yen)

10.7— Costs of a Global Single Currency What are the other costs? Of course, one important cost is the loss of thousands of jobs among those involved in some form or another in foreign exchange business within both the public and private sector. Within the private sector ( with respect to the dealers and traders) one way of attempting to

quantify the cost of the loss of such jobs would be from the FOREX dealers' association. One can obtain their memberships globally and arrive at some measure of opportunity cost of the jobs by summing their salaries and those of the associated staff–thus arriving at a figure for the cost of putting all the dealers and traders out of work. Of course, there would be the multiplier effect of the job losses, which in turn entail an extra factor and would have to be added to the calculation.

Page 95

10.8— A Global Central Bank There is the question of the "Global Central Bank", ie, the authority, or the single body that would manage such a global single currency. This would not be a major hurdle to overcome. An independent global central bank can be established in a similar fashion to the European Central Bank. It can also take an alternative form. However, for such an organisation to manage a global currency it would not be possible to have a monetary policy council with every country of the world as a member. That would make the system very inefficient. It would be preferable to model it perhaps partly on the US Federal Reserve Board. That is, although there are 50 states forming the "United States", at any given time there are only five to eight active members on the Board of the "US Fed". Moreover, although there are fifty states in the US there are only some 10 Reserve Banks. The development and emergence of a single currency would make many other tasks redundant, such as: · the work involved in the rescue packages of the International Monetary Fund (IMF) for the countries that have been victim of a crisis; · all the bail-out funds that have to be put together and given to these countries; · all the monitoring of the progress of the programmes that the IMF has to put in place following an unforeseen reversal of capital flows to bring the economy of these countries back to normality (only to see them subjected to yet another shock a few years later); · not to mention the contagion effect that accompanies any crisis that a single country suffers and the way it spreads. 10.9— Use of One Currency with the Development of e-commerce With the rapid growth of Internet technology and the phenomenal expansion of e-commerce, the emergence of a global single currency is inevitable. Pricing goods and services in US dollars, say, would be one way to reach the customer and further facilitate trade outside the geographical borders of the supplier country. By pricing their goods and services in a currency that attracts more business, there will be an inevitable global push towards a single currency. Undoubtedly, the development of e-commerce will provide the added impetus to converge towards pricing in a single currency and will inevitably lead to the emergence of a globally acceptable medium of exchange. Even if the politicians resist such a development along its route, the market by itself will bring about the emergence of a common currency. 10.10— Concluding Remarks Some may argue that the emergence of a global single currency is a long way off, while others believe that it is only a philosophical concept. But why should it be necessary for countries repeatedly to suffer speculative attacks before the world finally comes to the realisation and acceptance of one currency for the entirety of the global economy? Small open economies will continue to be vulnerable unless some drastic steps are taken to remedy the situation. Finally, with respect to a global single currency the same arguments that have been advanced in

favour of the formation of a common currency in any one block would be valid. The sceptics would argue that, as a result of the single currency, countries would no longer have the ability to control their monetary aggregates.

Page 96

Experience of the financial crises of Mexico, Czech Republic, Thailand, Russia and others has shown that the costs of the financial crises are far greater than the benefits provided by control of their monetary aggregates. As it has turned out and history has repeatedly demonstrated, once a financial crisis strikes such countries cannot exert any control on their monetary aggregates in any case. Moreover, a financial meltdown can result in a collapse of the banking as well as the payment system, paralysing the real economy, as has been the case in Korea, Mexico, Indonesia and Thailand. The critics of monetary union would argue that prevention of financial crises can be done through co-operation at several levels, namely: · at the international level; · at the regional level; and · at the country level. The experience of the recent decades has proved that very little has been and can be done at the international level and/or at the regional level. Thus, it comes down to concentrating all the efforts for the eradication of financial crises at the national level. "Crisis elimination" at the domestic level always points towards overburdening the home financial sector with stringent regulations. This can only lead to heavy and at times undue over-regulation of the financial sector at the domestic level. That is, to prevent further financial crises, the monetary authorities resort to the imposition of further rules on their financial market at home with the objective of creating more order and stability. Yet over-regulation can in turn be counter-productive, making the operation of the market inefficient. A global monetary union could materialise faster than can be anticipated. It is argued in this study that it would be far preferable to work for it rather than fight against it. That is to say, monetary authorities should work together to bring forward the emergence of a global single currency, whether it takes the form of the US dollar or another unit of currency that is more politically acceptable.

Page 97

Appendixes Appendix A— Total Reserves of All Countries as of May 1999 Table A1. Total reserves of all countries as of May 1999 Country

SDRs (millions)

US $ (millions)*

Afghanistan

N/A

N/A

Albania

N/A

N/A

Algeria

3,559

Antigua and Baruda Argentina

N/A 17,379

4,786.304 N/A 23,372.06

Armenia

212

285.1072

Aruba

189

254.1757

Australia Austria

9,835

13,226.55

10,596

14,249.98

Azerbaijan

469

630.7324

Bahamas, The

334

449.1783

Bahrain

936

1,258.775

1,058

1,422.846

Bangladesh Barbados

270

363.1082

Belarus

211

283.7623

Belgium

6,871

9,240.431

Belize

46

Benin

N/A

N/A

Bhutan

N/A

N/A

Bolivia

558

Botswana Brazil (April) Bulgaria Burkina Faso Burundi

4,118 31,426 1,835 N/A 43

Cambodia

259

Cameroon

N/A

Canada

16,097

61.86288

750.4236 5,538.073 42,263.11 2,467.791 N/A 57.82834 348.3149 N/A 21,647.97

Cape Verde

33

44.37989

Central African Rep.

N/A

N/A

Chad

N/A

N/A

Chile

11,681

15,709.14

China, P. Rep. Hong Kong

66,085

88,874.1

109,117

146,745.5

China, P. Rep. Mainland Colombia

5,679

Comoros

25

7,637.376 33.62113

Congo, Rep. of

N/A

N/A

Congo, Dem. Rep. of

N/A

N/A

Costa Rica Côte d'lvoire Croatia

1,047 N/A 1,767

1,408.053 N/A 2,376.341

Djibouti

46

Ecuador

1,189

1,599.021

N/A

N/A

Egypt El Salvador

1,390

61.86288

1,869.335

Equatorial Guinea

N/A

Estonia

472

Ethiopia

N/A

N/A

Fiji

281

377.9015

Finland

4,331

France

23,413

Gabon

N/A

Continued overleaf.

N/A 634.7669

5,824.525 31,486.86 N/A

Page 98 Table A1. Total reserves of all countries as of May 1999 (continued) Country Gambia, The Germany

SDRs (millions)

US $ (millions)* 79 37,709

Ghana

N/A

Greece

14,285

106.2428 50,712.77 N/A 19,211.11

Grenada

N/A

N/A

Guatemala

938

1,261.465

Guinea

N/A

N/A

Guinea-Bissau

N/A

N/A

Guyana

193

Haiti

N/A

N/A

Honduras

764

1,027.462

6,296

8,467.145

299

402.1087

Hungary Iceland

259.5551

India

22,765

30,615.4

Indonesia

18,734

25,194.33

Iran, I. Rep. of

N/A

N/A

Iraq

N/A

N/A

Ireland

3,403

4,576.508

Israel

16,026

21,552.49

Italy

12,367

16,631.7

Jamaica Japan Jordan

N/A 157,747 1,632

Kazakhstan

N/A

Kenya

447

Korea

45,397

Kuwait

2,834

N/A 21,2145.3 2,194.787 N/A 601.1458 61,051.94 3,811.291

Kyrgyz-Republic

130

174.8299

Laos, P. Dem. Rep.

N/A

N/A

Latvia

648

871.4597

Lebanon

4,744

Lesotho

N/A

N/A

Liberia

N/A

N/A

6,379.946

Libya

N/A

Lithuania

966

Luxembourg

N/A

Macedonia FYR

214

Madagascar

N/A

Malawi

196

N/A 1,299.12 N/A 287.7969 N/A 263.5897

Malaysia

20,933

Maldives

103

Mali

N/A

N/A

Malta

N/A

N/A

Mauritania

136

182.8989

Mauritius

420

564.835

22,825

30,696.09

Mexico

28,151.64 138.5191

Micronesia, Fed. States of

N/A

N/A

Moldova

136

182.8989

Mongolia

59

79.34587

Morocco

3,054

4,107.157

Mozambique

460

618.6288

Myanmar

N/A

N/A

Namibia

194

260.9

Nepal

N/A

N/A

Netherlands Netherlands Antilles New Zealand

4,838

6,506.361

N/A

N/A

2,745

3,691.6

Nicaragua

356

478.7649

Niger

N/A

N/A

Nigeria

N/A

N/A

Norway

13,588

(table continued on next page)

18,273.76

Page 99 Table A1. Total reserves of all countries as of May 1999 (continued) Country Oman

SDRs (millions)

US $ (millions)** 772

1,038.221

Pakistan

1,272

1,710.643

Panama

771

1,036.876

Papua New Guinea

N/A

N/A

Paraguay

381

512.386

Peru

6,828

9,182.603

Philippines

8,974

12,068.64

18,603

25,018.16

Poland Portugal Qatar

5,699 N/A

7,664.273 N/A

Romania

1,428

1,920.439

Russia

5,973

8,032.76

Rwanda

89

119.6912

Samoa

42

56.4835

São Tomé e Principe

N/A

Saudi Arabia

4137

Senegal

N/A

N/A 5,563.625 N/A

Seychelles

14

18.82783

Sierra Leone

16

21.51752

Singapore

54,020

72,648.54

Slovak Rep.

1,829

2,459.722

Slovenia

2,557

3,438.7691

38

51.10412

Solomon Islands South Africa Spain Sri Lanka

3,167 25,302 1,244

4,259.125 34,027.27 1,672.987

St Kitts and Nevis

N/A

N/A

St Lucia

N/A

N/A

St Vincent and the Grenadines

N/A

N/A

Sudan

N/A

N/A

Surinam Swaziland Sweden

44

59.17319

N/A

N/A

9,177

12,341.64

Switzerland

24,143

3,2468.6

Syrian Arab. Rep.

N/A

N/A

Tanzania

438

589.0422

Thailand

22,016

Togo Tonga

N/A 19

29,608.11 N/A 25.55206

Trinidad and Tobago

509

684.5262

Tunisia

N/A

N/A

Turkey

16,190

Uganda

N/A

N/A

Ukraine

483

649.5602

6,864

9,231.018

United Arab Emirates

21,773.04

United Kingdom (April)

17,563

23,619.52

United States

22,009

29,589.7

Uruguay

N/A

Vanuatu

30

Venezuela

N/A 40.34536

8,070

10,852.9

Vietnam

N/A

N/A

Yemen Arab. Rep.

N/A

N/A

Yemen P. Dem. Rep.

N/A

N/A

Yemen, Rep. of

N/A

N/A

Yugoslavia, SFR

N/A

N/A

Zambia Zimbabwe

50 110

*SDRs conversion rate: 0.74358 = 1 US dollar for May 1999. Source: IMF, 1999, International Financial Statistics, LII, no 8, August.

67.24226 147.933

Page 101

Appendix B— Balance Sheets This Appendix contains the balance sheets of the central banks of the following countries: · Argentina

· Italy

· Australia

· Japan

· Austria

· Korea

· Bahrain

· Kuwait

· Belgium

· Lebanon

· Brazil

· Lithuania

· Bulgaria

· Malaysia

· Canada

· Malta

· Cyprus

· Mauritius

· Czech Republic

· Mexico

· Denmark

· Netherlands Antilles

· Estonia

· New Zealand

· Finland

· Portugal

· France

· Singapore

· Germany

· Slovakia

· Greece

· South Africa

· Hong Kong

· Spain

· Hungary

· Sweden

· Iceland

· Switzerland

· India

· Thailand

· Indonesia

· Turkey

· Ireland

· UK

· Israel

· US

Page

Page 103 Reserve Bank of Australia. Balance sheet as of June 30, 1999 Assets

A$ (thousands)

Cash and liquid assets

587

Domestic government securities

21,633

Foreign exchange

25,370

Gold

1,013

Loans, advances and bills discounted

76

Other assets

129

Property, plant and equipment

265

Total Assets

49,073

Liabilities

A$ (thousands)

Due to other financial institutions

–

Deposits

10,383

Profit distribution payable to commonwealth

3,676

Other liabilities

4,225

Australian notes on issue

23,552

Capital and reserves Reserves: Unrealised profits reserve

–

Asset revaluation reserve

1,045

Reserve for contingencies and general purposes

3,323

Reserve bank reserve fund Capital Capital and reserves Total liabilities Source: Reserve bank of Australia, 1999, Report and Financial Statements August 3.

2,829 40 7,237 49,073

Page 104 National Bank of Austria. Balance sheet as of December 31, 1998 Assets

Austrian Schillings

Gold

32,691,972,111.81

Foreign exchange and currency

245,745,855,037.39

Claim arising from participation in the European Central Bank (ECB)

1,623,302,591

Other claims on ECB

–

SDRs within the IMF

1,754,713,152.77

Claim arising from participation in the IMF

19,694,456,412

Less: Schilling balance at the disposal of the IMF

4,260,907,333.91

Other claims on IMF

15,433,549,078.09 1,458,182,690.57

Claims arising from loans to foreign central banks

47,174,568

Austrian coin

1,538,181,794.68

Discounted bills of exchange

–

Claims resulting from ERP credits extended by the National Bank of Austria

8,791,647,503

Open market transaction securities

18,120,000,000

Claim on Austrian Federal Treasury

2,676,499,051.41

329,881,077,578.72

Other assets Premises Equipment

175,959,078.69

Securities

398,682,474.47

Sundry assets

20,391,242,335

Transitory items

15,981,602,522.11 90,839,509.01

37,038,325,919.28 366,919,403,498

Liabilities

Austrian Schilling 150,000,000

Capital Reserves General reserve fund

22,180,947,260.63

Freely disposable reserve fund

28,606,583,003.88

Reserve fund for exchange risks

44,972,193,829.18

Other reserves

6,642,717,438.45

Pension reserve

23,814,000,000

Banknotes in circulation

168,822,605,900

Deposits on giro accounts and other

126,216,441,532.14

sight labilities Domestic credit institutions

54,693,305,159.17

Foreign credit institutions and monetary authorities

209,354,806.85

Austrian public authorities and residents

283,745,421.92

IMF SDRs allocated

2,967,427,373.80

224,009,011,287.94

Other liabilities Provisions for severance payments

555,058,676

Other provisions

714,512,279.45

Sundry liabilities

11,167,135,197.77

Transitory items Retained earnings

–

12,436,706,153.22 1,139,817,150.90 366,919,403,948

Page 105 Bahrain Monetary Agency. Balance sheet as of March, 1999 Assets

BD (millions)

Foreign assets: Gold

2.5

Foreign exchange

363.4

Claims on reserve banks

137.5

Claims On Government

53.2

Other assets Liabilities Foreign liabilities Currency issued

8.7 BD (millions) 0 122.1

Resident banks deposits

76.6

Government deposits

28.3

Liabilities to non-bank

42.4

Other liabilities

1

Capital and reserves

294.9

Balance sheet total

565.3

Page 106 National Bank of Belgium. Balance sheet as of December 31, 1998 Assets

Bfr (thousands)

Gold

94,659,014

Foreign currencies.

518,693,131

SDRs

21,050,731

Participation in the IMF

58,727,566

Loans to the IMF

6,786,157

Deposit with the IMF within the framework of the ESAF

8,745,804

Ecus

–

EMI: Very short- and short-term financing

–

EC: Medium-term financial assistance

–

International agreements

3,346,161

Open-market transactions: Main refinancing operations

184,925,000

Fine-tuning transactions on the basis of repurchase agreements and/or collateralised loans

–

Securities purchased in the market Commercial bills

25,687,561 –

Marginal lending facility

143,041

Participation in the capital of the ECB

5,780,304

Coins

229,461

Statutory investments (Article 21)

53,169,006

Premises, equipment and furniture

12,570,636

.Other assets

1,926,123

Regularisation accounts

10,369,657

Total assets Liabilities

1,006,809,353 Bfr (thousands)

Notes in circulation

482,919,952

Monetary reserve account

278,762,708

Deposit facility

242,830

Deposit of the Belgian State

430,438

Deposit of the Luxembourg State

–

Other current accounts in francs

13,183,923

Liabilities due to interventions in the money market

–

Current account in foreign currencies

–

Counterpart of allocations of SDRs ECB: Very-short- and short-term financing

23,577,036 –

Unavailable reserve of capital gains on gold Other liabilities Regularisation accounts

– 32,830,797 1,270,338

Valuation differences on gold and foreign exchange

92,710,793

Provision for future exchange losses

13,200,000

Provision for premises Provision against sundry contingencies

1,396,981 12,700,000

Capital

400,000

Reserve fund:

400,000

Statutory reserve

3,613,644

Extraordinary reserve

37,621,631

Account for depreciation of premises, equipment and furniture

11,948,282

Total liabilities

1,006,809,353

Page 107 Central Bank of Brazil. Balance sheet as of December 31, 1997 Assets Long-term assets and receivables

R$ 182,021,666,237.65

Foreign

61,663,971,697.74

Foreign sector operations

63,847,308,917.13

(Provision for hard-to-recover credits)

(2,183,337,219.39)

Internal Operations

120,357,694,539.91 53,658,346,205.61

Loans to financial institutions

15,769,430,504.42

Federal public securities–open market

35,102,562,110.23

(Provision for reduction to market value)

(260,395,601.92)

Security operations–resale commitments

1,050,687,377.65

National treasury notes–NTN

1,981,787,419.47

Operations with non-earmarked resources

9,687,510.54

Other securities

4,586,885.22

Other credits

56,421,164,324.50

Credits receivable

33,146,456,270.95

Securities receivable

25,880,941,773.78

Credits registered under debts in execution Debtors of real estate commitments (Provision for hard-to-recover credits) Other accounts Amounts registered in foreign currencies

781,395,483.68 6,905,105.63 (3,394,534,309.54) 10,264,789,656.42 12,290,359.24

Fines

358,055,496.55

Deposits earmarked to appeals

209,859,384.27

Results to offset Other accounts (Provision for hard-to-recover credits) Securities and goods

11,603,432,991.91 79,888,935.44 (1,998,737,510.99) 13,291,458.67

Inventory

3,337,796.99

Real estate not reserved to use

9,953,661.68

Expenditures anticipated or to be appropriated

102,894.71

Permanent

5,695,701,267.94

Investments

4,935,992,606.13

Capital quotas in international financial organisation

4,935,992,606.13

IMF

3,264,297,084.00

Inter-American Development Bank–IDB

1,087,410,972.85

International Bank for Reconstruction and Development–IBRD

206,544,586.52

Other organisations

377,739,962.76

Immobilised

759,708,660.91

Movable properties

86,26,3,848.49

Real estate

753,834,099.94

(Accumulated depreciation)

(80,518,204.86)

Intangible goods Total assets

128,917.34 187,717,367,504.69

Page 108 Central Bank of Brazil. Balance sheet as of December 31, 1997 Liabilities

R$

Long-term current and callable liabilities

163,896,109,035.84

Foreign

7,793,100,933.83

Foreign currency liabilities

3,619,532,877.68

Deposits of international financial organisations

4,045,388,916.06

Earmarked resources

127,757,840.01

Other accounts

421,300.08

Internal

156,103,008,102.01

Financial institution deposits

42,181,116,148.87

Banking reserves

11,555,036,266.41

Deposits of Brazilian savings and loan system

14,096,937,463.60

Compulsory reserves on time deposits

16,766,345,302.89

Compulsory reserves on judicial deposits

3,298,776,665.52

Other reserves

379,691,037.07

(Deposits in public securities)

(3,915,670,586.62)

Deposits at orders of federal government

41,135,317,817.91

Single national treasury account

32,189,326,324.27

Resources of diverse origins

–

Compulsory loans–vehicles

1,735,192,741.53

Compulsory loans–fuels

7,210,798,752.11

Other deposits

4,150,615,262.10

Financial investment funds

3,726,163,757.91

Deposits registered in foreign currency

12,313,699.91

Earmarked deposits–financial institutions under intervention

403,078,234.17

Other accounts

9,059,570.11

Other liabilities callable;

68,037,623,002.11

Banco Central Bonds–BBC

28,326,937,946.94

Banco Central Bills–LBC

25,766,111,285.44

Banco Central Notes–NBC

11,628,843,030.14

Security operations–repurchase commitments

2,103,346,927.28

Funds and programs—available at Banco Central

77,128,964.43

Remainder to be paid—expenditures processed

24,130,282.91

Remainder to be paid—expenditures not processed Other accounts Other accounts

– 111,124,564.97

598,335,871.02 Other liabilities registered in foreign currency

141,342,222.05

Earnings on federal government deposits, to be deposited

226,425,309.41

Other accounts

230,568,339.56

Currency

20,250,731,906.63

Net worth

3,570,526,562.22

Equity

2,576,356,440,43

Contingency reserves

467,818,844.79

Re-evaluation reserves

526,351,277.00

Total liabilities

187,717,367,504.69

Page 109 Bulgarian National Bank. Balance sheet as of December 31, 1998 Assets Cash and amounts due from banks Gold and other precious metals Securities Loans to bank and other financial institutions Interest receivable

Lv (millions) 2,971,965 697,024 1,572,435 1,350 17,877

Receivable from Government

1,665,949

Equity investments and quota in IMF

1,102,701

Fixed assets

139,624

Other assets

8,760

Total assets

8,177,685

Liabilities Due to bank and other financial institutions

Lv (millions) 551,436

Government deposits and accounts

1,947,104

Borrowings against Bulgaria's IMF quota

1,018,707

Borrowings from general resources of IMF

1,866,957

Other borrowings Currency in circulation Accruals and other liabilities Total liabilities

17,944 1,845,056 94,370 7,341,574

Shareholder's fund Capital Reserves Total liabilities and shareholder's fund

20,000 8,16,111 8,177,685

Page 110 Bank of Canada. Balance sheet as of December 31, 1996 Assets

C$ (millions)

Deposits in foreign currencies US dollars

235.0

Other currencies

4.0 239.0

Advances to members of the Canadian Payments Association

553.8

Investments Treasury bills of Canada

17,416.5

Other securities issued or guaranteed by Canada maturing within three years

2,328.3

Other securities issued or guaranteed by Canada not maturing within three years

5,635.2

Other investments

3,942.4 29,322.4

Bank premises

198.2

Other assets

271.0

Total assets

30,584.4

Liabilities

C$ (millions)

Capital paid up Rest fund Banknotes in circulation

5.0 25.0 29,109.1

Deposits Government of Canada Chartered banks Other members of the Canadian Payments Association Other deposits

11.0 945.5 14.6 347.8 1,318.9

Liabilities in foreign currencies Government of Canada

91.0

Other liabilities

35.4

Total liabilities

30,584.4

Central Bank of Cyprus. Balance sheet as of November 30, 1998 Assets International reserves Repos Advances:

C£ (thousands) 786,339 90,000

Government and government agencies

347,552

Banks

23,481

Government securities and treasury bills

193,273

Other assets

48,152

Total Assets or Liabilities Liabilities

1,488,797 C£ (thousands)

Capital and reserves: Capital Special reserve

15,000 –

General reserve

15,000

Currency in circulation

292,727

Deposits: Government and government agencies

285,313

Banks

591,483

Other

2,860

Reverse repos Accounts under trade and payments agreements Other liabilities

– 62 286,352

Page 111 Czech National Bank. Balance sheet as of June 30, 1999 Assets Bullion Receivables from the IMF in foreign currency Receivables from the IMF in Czech crowns Receivables from foreign countries in foreign currency Receivables from foreign countries in Czech crowns

Kc 541.1 0.00 39,404.6 464,978.3 0.00

Receivables from domestic banks

50,264.3

Loans provided to clients

28,610.8

Domestic securities and interests

17,177.9

The current performance of the state budget

0.00

Other receivables from the state budget

0.00

Cash

996.8

Other assets

14,439.2

Total assets

616,412.9

Liabilities Currency in circulation Payables to the IMF in foreign currency

Kc 159,723.4 0.0

Payables to the IMF in Czech crowns

39,404.6

Payables to foreign countries including securities in foreign currency

25,724.8

Payables to foreign countries including securities in Czech crowns Payables to domestic banks Client deposits Issue of bonds and similar bills The current performance of the state budget

430.1 278,949.3 26,533.8 0.0 4,694.6

Other payables to the state budget

15,552.4

Reserves

54,369.7

Capital

1,400.0

Other funds

8,219.6

Retained earnings or losses brought forward Current profit or loss

–50,740.1 42,565.9

Other liabilities

9,584.7

Total liabilities

616,412.9

Page 112 National Bank of Denmark. Balance sheet as of December 31, 1998 Assets

Dkr (thousands)

Stock of gold

3,933,559

Foreign assets

89,416,246

Claims on the European Monetary Institute Claims on the IMF, including SDR holdings

– 9,329,804

Loans, etc

40,225,314

Bonds and shares, etc

37,486,642

Other assets

2,383,086

Accruals Total assets Liabilities Banknotes

19,247 182,793,898 Dkr (thousands) 37,198,773

Coins

3,815,871

Foreign liabilities

1,252,999

Allocations of SDRs in the IMF

1,605,805

Deposits, etc

21,230,616

Certificates of deposit

34,752,000

Central government

37,130,934

Other liabilities

2,333,031

Total creditors

139,320,029

General capital fund Statutory reserve Value adjustment reserve

50,000 250,000 3,101,450

General reserves

40,072,419

Total net capital

43,473,869

Total liabilities

182,793,898

Off-balance-sheet items Guarantees Other liabilities

688,508 74,533,935 75,222,443

Page 113 Bank of Estonia. Balance sheet as of July 31, 1999 Assets Foreign assets Gold Convertible foreign currency assets

US$ 903,364,618.39 2,177,630.68 811,394,422.89

SDRs

35,920.73

Participation in IMF

88,804,144.57

Other claims to IMF

952,394.49

Non-convertible foreign currency Domestic assets Loans

105.03 35,562,690.26 4,426,877.01

Government

267,590.59

Financial institutions

935,132.53

Other

3,224,153.90

Bonds

0.00

Shares and participation

18,167,185.55

Other assets

2,365,573.59

Fixed assets

10,603,054.12

Total assets

938,927,308.65

Liabilities Foreign liabilities

US$ 171,063,483.73

Foreign debts

81,977,034.23

IMF kroon accounts

89,062,371.22

Accounts of non-residents

24,078.28

Domestic liabilities

619,591,473.50

Notes and coins in circulation

392,888,549.42

Accounts of banks and other current liabilities

224,258,025.14

Accounts of banks Other Securities (certificates of deposits issued) Convertible foreign currency depossits Non-convertible foreign currency deposits Other liabilities Provisions Capital and reserves, profit/loss Total liabilities

224,034,120.38 223,904.76 0.00 658,085.42 0.00 1,752,612.88 34,200.64 148,272,351.42

938,927,308.65

Page 114 Bank of Finland. Balance sheet as of December 31, 1998 Assets

FM (millions)

Reserve assets

51,564

Gold

2,180

SDRs

1,770

Other claims on the IMF

4,255

Ecu claim on the European Monetary Institute

–

Foreign exchange assets

43,358

Other foreign claims

2,548

Markka subscription to Finland's quota in the IMF

2,132

European Central Bank capital share

416

Claims on financial Institutions

82

Liquidity credits

–

Securities with repurchase commitments

–

Term credits

–

Bonds

63

Other

19

Claims on the public sector

2,074

Treasury bills

–

Bonds

–

Total coinage Other claims on the public sector

2,074 –

Claims on corporations

1,479

Financing of domestic deliveries (KTR)

6

Other

–1,473

Other assets

540

Accrued items

440

Other

100

Valuation account Total assets Liabilities

– 58,286 FM (millions)

Foreign liabilities

3,886

Allocations of SDRs

1,021

IMF markka accounts

2,133

Other Notes and coin in circulation Notes

733 17,689

15,740 Coin

1,949

Certificates of deposits

4,950

Liabilities to financial institutions

12,938

Reserve deposits

12,938

Term deposits

–

Other

0

Liabilities to the public sector

–

Current accounts

–

Other

–

Liabilities to corporations

5

Deposit for investment and ship purchase

5

Other

–

Other liabilities

286

Accrued items

251

Other

37

Valuation accunt Provisions Pension Provisions Other

12,765 1,690 11,075

Capital accounts

5,764

Primary capital

5,000

Reserve fund

764

Net earnings

0

Total liabilities

58,286

Page 115 Bank of France. Balance sheet as of June, 1999 Assets

Outstanding amounts of euros (billions)

National territory

24.4

Loans

21.9

MFIs

20.1

Central government

1.8

Private sector

0.0

Securities other than shares

2.5

MFIs

0.0

Central government

2.5

Private sector

0.0

Money market paper

0.0

Shares and other equity

0.0

Other euro area countries

9.3

Rest of the world

73.4

Gold

25.3

Not broken down by geographical area

13.0

Total assets Liabilities

145.4 Outstanding amounts in euros (billions)

National territory–deposits

30.4

MFIs

28.1

Central government

1.5

Other sectors

0.9

Other euro area countries–deposits

39.2

MFIs

39.2

Other sectors

0.0

Rest of the world–deposits

0.9

Not broken down by geographical area

74.9

Banknotes and coins in circulation

44.8

Debt securities issued

0.0

Money market paper

0.0

Capital and reserves

24.5

Other liabilities

5.6

Total liabilities

145.4

Page 116 Deutsche Bundesbank. Balance sheet as of January 1, 1999 Assets

Euros (millions)

1 Gold and gold receivables 2 Claims on non-euro-area residents denominated in foreign currency

29,312 –

2.1 Receivables from the IMF

8,461

2.2 Balances with banks, securities investments, external loans and other external assets

56,113 64,574

3 Claims on euro-area residents denominated in foreign currency

–

4 Claims on non-euro-area residents denominated in euro

128

5 Lending to financial sector counterparts in the euro area 5.1 Main refinancing operations

83,121

5.2 Longer-term refinancing operations

24,698

5.3 Fine-tuning reverse operations 5.4 Structural reverse operations 5.5 Marginal lending facility

2,598

5.6 Other lending

5 110,422

6 Securities of euro-area residents denominated in euro 7 Claims on the Federal Government

4,440

8 Intra-Eurosystem claims 8.1 Participating interest in the ECB

1,225

8.2 Claims arising from the transfer of foreign reserve assets to the ECB

–

8.3 Other claims within the Eurosystem

– 1,225

9 Items in course of settlement

284

10 Other assets 10.1 Coins

811

10.2 Tangible and intangible fixed assets

2,162

10.3 Other financial assets 10.4 Off-balance-sheet instruments revaluation difference

51 –

10.5 Accruals and deferred expenditu re

799

10.6 Sundry items

453 4,276

Total assets

214,661

Page 117 Deutsche Bundesbank. Balance sheet as of January 1, 1999 Liabilities

Euros (millions)

1 Banknotes in circulation 2 Liabilities to euro-area financial sector counterparties denominated in euro

130,551 –

2.1 Current accounts

29,325

2.2 Deposit facility

–

2.3 Fixed-term deposits

–

2.4 Fine-tuning reverse operations 29,325 3 Liabilities to other euro-area residents denominated in euro 3.1 General government deposits

149

3.2 Other liabilities

707 856

4 Liabilities to non-euro-area residents denominated in euro

8,094

5 Liabilities to euro-area residents denominated in foreign currency

10

6 Liabilities to non-euro-area residents denominated in foreign currency

0

7 Counterpart of SDRs allocated by the IMF

1,458

8 Intra-Eurosystem liabilities 8.1 Liabilities to the ECB arising from promissory notes 8.2 Other liabilities within the Eurosystem

– 5 5

9 Items in course of settlement

36

10 Other liabilities 10.1 Off-balance-sheet instruments revaluation differences

38

10.2 Accruals and deferred income

32

10.3 Sundry items

86 156

11 Provisions 12 Revaluation accounts

5,441 25,322

13 Capital and reserves 13.1 Capital

2,556

13.2 Statutory reserves

2,556 5,112

14 Unappropriated profit for 1998 Total liabilities

8,295 214,661

Page 118 Bank of Greece. Balance sheet as of December 31, 1998 Assets

US $ (millions)

Cash and due from banks Obligatory deposits with central bank

549 6,471

Federal funds sold and securities purchased under agreements to resell Interest bearing deposits with banks

24 6,353

Money market investments

162

Trading securities: Debt and equity instruments

7,720

Securities: Available-for-sale, at fair value Held-to-maturity, at amortised cost (fair value of Dr 651,641 million and Dr 1,843,956 million at December 31, 1997 and 1998, respectively). Loans Less: Allowance for loan losses Net loans

3,649 5,719 12,978 (907) 12,071

Intangible assets

108

Premises and equipment, net

404

Customers' liability on acceptances

1

Accrued interest receivable

883

Other assets

1,606

Total assets

45,720

Liabilities Non-interest-bearing deposits

US $ (millions) 3,821

Interest-bearing deposits

33,140

Total deposits

36,961

Central bank borrowings

2,110

Securities sold under agreements to repurchase

893

Other borrowed funds

490

Acceptances outstanding Accounts payable, accrued expenses and other liabilities

1 3,414

Long-term debt

324

Insurance reserves

565

Minority interests

135

Mandatory convertible bond

197

Total liabilities

45,090

Shareholders' equity Common stock, par value Dr 5,800 (shares authorised, issued and outstanding at 1997– 27,012,278 and at 1988–35,401,744)

659

Additional paid in capital

281

Accumulated deficit Accumulated other comprehensive income Treasury stock, at cost Total shareholders' equity Total liabilities and shareholders' equity

(247) 127 (190) 630 45,720

Page 119 Hong Kong Monetary Authority. Exchange fund balance sheet as of April 30, 1999 Assets Foreign currency assets

HK$ (millions) 706.491

of which: gold Hong Kong dollar assets

249,214

Total assets

955,705

Liabilities Certificate of indebtedness

HK$ (millions) 89,745

Coins in circulation

5,733

Balance of banking system

4,325

Exchange Fund bills and notes Placements by other government funds

98,404 423,830

Placements by other institutions

26,905

Other liabilities

38,756

Total

687,698

Accumulated surplus

268,007

National Bank of Hungary. Balance sheet as of December 31, 1997 Stock of foreign assets and liabilities of the Government and National Bank of Hungary, 1997 1 International reserves and other foreign assets 1.1 International reserves of which: gold

US $ (millions) 9,147 8,429

1.2 Direct investment 1.2.1 Equity capital abroad

92

1.3 Portfolio investment

0

1.3.1 Equity securities

0

1.3.2 Bonds and notes

0

1.3.3 Money market instruments

0

1.3.4 Financial derivatives

0

1.4 Other foreign assets by original maturity:

625

1.4.1 Short-term

38

1.4.2 Long-term

586

2 Gross foreign liabilities

13,791

2.1 Direct investment 2.1.1 Equity capital in Hungary 2.2 Portfolio investment

0 10,093

2.2.1 Equity securities

0

2.2.2 Bonds and notes

9,652

2.2.3 Money market instruments 2.2.4 Financial derivatives 2.3 Other foreign liabilities by original maturity:

0 441 3,698

2.3.1 Short-term

78

2.3.2 Long-term

3,620

3 Net foreign liabilities

4,644

4 Net foreign debt

4,737

4.1 Gold and gross foreign assets, constituting debt of non-residents

9,054

Page 120 Central Bank of Iceland. Balance sheet as of December 31, 1998 Assets Convertible foreign assets Gold

IKr 35,134,700,484 196,248,820

SDRs IMF reserve position

1,186,941 1,022,884,996

Foreign correspondents

11,145,457,029

Foreign securities and treasury bills

22,768,922,698

Deposit money banks

19,599,708,912

Securities. Repurchase agreements

1,944,363 18,089,361,573

Short-term loans

1,508,402,976

Investment credit funds

7,769,610,816

General debentures

0

Marketable securities

3,035,749,097

Repurchase agreements

4,733,861,719

Foreign funds re-lent

0

Central government

5,002,126,327

Treasury current accounts

114, 756,676

Marketable securities

3,098,409,651

Treasury bills

1,788,960,000

Other sectors

121,863,208

Treasury current accounts Securities Counterpart to IMF deposits Cash and sundry items

8,734,149 113,129,059 7,289,676,014 57,250,205 74,974,935,966

Liabilities

lkr

Notes and coin

7,574,022,000

Deposit money banks Sight deposit Required deposits Foreign exchange deposits Investment credit funds

12,988,415,873 2,305,479,441 10,682,936,432 0 4,127,892,414

Sight deposits

2,062,679,985

Required deposits

1,906,210,684

Foreign exchange deposits Central government Treasury current accounts Government institutions

159,001,745 13,173,050,865 9,932,002,916 245,556,555

Foreign exchange deposits

.2,995,491,395

Public depository funds

2,584,392

Other sectors

73,383,317

Short-term foreign liabilities

3,954,098,651

Long-term foreign liabilities

5,118,881,523

IMF deposits

7,289,676,014

IMF allocations of SDRs

1,609,031,252

Deposits of IBRD and affiliated institutions

35,381

Sundry items

775,486,745

Pension fund obligations

318,930,000

Capital and other reserves

17,969,447,538

Original capital contribution

1,000,000

Dividend fund

1,556,750,000

Other reserves

16,411,697,538 74,974,935,966

Page 121 Reserve Bank of India. Balance sheet as of June 30, 1999 Assets

Rs (millions)

Gold coin and bullion: Held in India

104,746.3

Held outside India Foreign securities

507,000.0

Total

611,746.3

Rupee coin

818.3

Government of India Rupee securities

956,058.3

Internal bills of exchange and other commercial paper Total assets Liabilities Notes held in the banking department

1,568,622.9 Rs (millions) 211.9

Notes in circulation

1,568,411.0

Total notes issued

1,568,622.9

Total liabilities

1,568,622.9

Page 122 Bank of Indonesia. Balance sheet as of May, 1999 Assets

Rp (millions)

Gold and foreign assets

221,127

(a) Gold and foreign exchange

210,384

(b) Other foreign assets 743

743

Claims on public sector

202,348

(a) Central government

179,282

(b) Official entities

0

(c) Claims on special government institution

23,066

Claims on banks

32,923

Money market securities

1,008

Claims on non-bank private sector

4,621

Other assets

6,487

Assets = Liabilities Liabilities Monetary liabilities

458,514 Rp (millions) 71,644

(a) Currency in circulation

51,005

(b) Bank's demand deposits

19,254

(c) Non-bank private sector demand deposits Foreign exchange (a) Bank's demand deposits (b) Other demand deposits Foreign liabilitis

1,385 6,976 6,888 88 101,398

(a) Foreign exchange liabiilties

27,413

(b) Other foreign liabilities

73,985

Government account

67,766

(a) Current account

66,159

(b) Blocked account (c) Counterpart funds Proceeds of Government bond abroad Foreign aids (d) Import guarantee deposits

0 376 0 376 1,205

(e) Other

0

(f) Special government institution

26

Bank of Indonesia certificates

74,137

Capital account

2,933

Other liabilities

133,660

Page 123 Central Bank of Ireland. Balance sheet as of June, 1999 Assets

1£ (millions)

1 (a) Gold

49

(b) External balances and securities

4,561

2 IMF

1,116

(a) Holdings of SDRs

32

(b) Quota of Ireland

1,084

3 Marginal lending facility and other secured advances

21

4 Sale and repurchase agreements

3,106

5 Irish Government securities: certificates of indebtedness

167

6 Other assets

5,748

Total assets Liabilities

14,768 1£ (millions)

1 Currency

3,795

2 Deposits:

8,124

(a) Government (including normal suspense accounts)

3,394

(b) Credit institutions: mandatory balances

4,501

(c) Credit institutions: other balances 3 IMF:

229 731

(a) SDR allocation account

113

(b) Deposit and demand notes accounts

618

4 Capital and reserves 5 Other liabilities Total liabilities

1,968 150 14,768

Page 124 Bank of Israel. Balance sheet as of 1998 Assets

US $ (million)

Total

40,696

Bank of Israel reserves

22,674

Other financial institutions Exporters credit abroad

367 3,088

Banking system

14,567

Net liabilities

14,162

Liabilities

US $ (millions)

Total

5 4,858

Government

27,347

Non-financial private sector Banks

8,256 19,255

Page 125 Bank of Italy. Balance sheet as of May 31, 1999 Assets Total assets

Euros (millions) 157,547.604

Gold and gold receivables

20,526.002

Claims on non-euro-area residents denominated in foreign currency

20,215.042

Receivables from the IMF Balances with banks and security investments, external loans and other external assets Claims on euro-area residents in foreign currency

4,343.276 15,871.766 1,591.277

Claims on non-euro-area residents in euro

0.000

Balances with banks, security investments and loans

0.000

Claims arising from the credit facility under the ERM II

0.000

Lending to financial sector counterparties of euro-area

21,510.652

Main refinancing operations

19,153.593

Longer-term refinancing operations

2,354.389

Fine-tuning reverse operations

0.000

Structural reverse operations

0.000

Marginal lending facility

0.000

Credits related to margin calls

0.000

Other lending

2.670

Securities of euro-area residents denominated in euro

1,562.087

General government debt denominated in euro

40,851.541

Other assets

51,285.053

Claims related to the transfer of foreign currency reserves Claims within the Eurosystem (net) Liabilities Total liabilities Banknotes in circulation

8,192.250 0.000 Euros (millions) 157,547.604 61,602.214

Liabilities to euro-area financial sector counterparties denominated in euro

9,877.416

Current accounts (covering the minimum reserve system)

9,877.147

Deposit facility

0.212

Fixed term deposits

0.000

Fine-tuning reverse operations

0.000

Deposits related to margin calls

0.057

Debt certificates issued

0.000

Liabilities to other euro-area residents in euro

21,831.498

General government Other liabilities Liabilities to non-euro-area residents in euro Liabilities to euro-area residents in foreign currency

21,610.327 221.171 9,556.598 –0.283

Liabilities to non-euro-area residents in foreign currency

508.340

Deposits, balances and the other liabilities

508.340

Liabilities arising from the credit facility under the ERM II Counterpart of SDR allocated by the IMF Other liabilities Liabilities within the Eurosystem (net)

0.000 887.959 9,043.963 525.704

Revaluation accounts

15,924.064

Capital and reserves

28,316.105

Page 126 Bank of Japan. Balance sheet as of July 31, 1999 Assets

¥ (thousands)

Gold

432,895,734

Cash

274,025,742

Bills purchased

3,440,100,000

Japanese government securities in custody

2,003,300,000

Japanese government securities Commercial bills discounted

50,243,194,852 11,563,671

Loans

1,160,770,015

Loans to Deposit Insurance Corporation

3,524,500,000

Foreign exchange

3,882,175,010

Deposits with agencies

373,246,150

Cash collateral in exchange for Japanese government securities borrowed

2,081,158,509

Others

1,206,031,926

Total assets Liabilities Banknotes Current deposits Other deposits

68,632,961,613 ¥ (thousands) 52,135,516,008 4,897,614,493 241,928,385

Deposits of the Japanese government

1,660,758,766

Bills sold

1,100,500,000

Japanese government securities borrowed

2,003, 300,000

Others

1,715,981,865

Allowances and accrued liabilities

2,669,074,447

Capital Reserves Total liabilities

100,000 2,208,187,647 68,632,961,613

Page 127 Bank of Korea. Balance sheet as of end of 1998 Assets and liabilities

Won (billions)

Assets

127,865.4

Current assets

125,226.6

Cash

134.0

Gold and silver bullion

74.6

Holdings of SDRs

13.8

Securities

61616.3

Due from banks

43,989.3

Bills discounted

0

Loans against bills

14,303.5

Loans to government

849.0

Loans to international financial institutions

111.3

Other current assets

3 418.8

Fixed assets

2,638 .8

Liabilities and capital

127,865.4

Liabilities

122,484.5

Current liabilities

121,865.5

Currency issued

15,934.1

Monetary Stabilisation Bonds issued

45,673.3

Monetary Stabilisation Account Deposits Allocation of SDRs Securities sold under repurchase agreements Other current liabilities (Exchange revaluations adjustment)

5,914.9 37,867.8 123.4 3,500.0 12,850.3 (11,883.6)

Long-term liabilities

619.0

Allowances

165.6

Liabilities to international financial institutions

453.4

Capital Legal reserve

5,380.9 457.0

Voluntary reserve

1,543.0

Undivided profit surplus

3,380.9

(Net profit for the period)

(1,661.9)

Page 128 Central Bank of Kuwait. Balance sheet as of July, 1999 Foreign assets

KD (thousands)

Gold

31.7

Deposits and cash balances

1084.3

Other Total

1116.0

Rediscounted commercial papers Deposits and current accounts with local banks

12.0

Claims on Government Other assets

12.2

Total assets Liabilities

1,140.2 KD (thousands)

Reserve money (monetary base) Currency issued

404.5

Current account balances with Central Bank of Kuwait

8.9

Total

413.4

Government accounts

312.5

Deposits against letters of credit

18.3

Deposits and reserve

184.0

Accounts of international organisations

2.5

Local bank deposits

40.0

Other liabilities

169.5

Total liabilities

1,140.2

Central Bank of the Lebanon. Balance sheet as of May, 1999 Assets

L£ (billions)

Gold

3,759.8

Foreign currencies

9,427.4

Other foreign assets

17.4

Claims on private sector

226.21

Loans to commercial banks Loans to specialised financial corporations Loans to public sector Securities portfolio

254.6 – 103.8 1,054.3

Fixed assets

171.9

Unclassified assets

247.6

Total assets Liabilities

15,263.0 L£ (billions)

Currency In circulation outside BDL (Banque du Liban)

1,313.9

Commercial banks deposit

6,512.3

Specialised banks and financial corporations deposit

56.3

Private sector deposits

24.0

Public sector accounts

1,819.0

Valuation adjustment

2,714.0

Foreign liabilities Special long-term liabilities

262.8 1,068.1

Capital accounts

863.9

Unclassified liabilities

628.7

Total liabilities

15,263.0

Page 129 Bank of Lithuania. Balance sheet as of August 1998—August 1999 Assets

Litas (millions)

Foreign assets

4,943.4

Claims on: Central Government

6.8

Private sector

6.3

Commercial banks Non-bank financial institutions

51.4 –

Other assets Total assets Liabilities

5,237.0 Litas (millions)

Foreign liabilities IMF loans to LB

361.4

Liabilities to non-residents of which in foreign currency

2.9

Domestic liabilities

0.0

Currency outside the LB

2,985.3

Deposits with commnercial banks

939.8

of which in foreign currency

380.7

Central Government deposits

420.7

of which in foreign currency

377.7

Deposits of other residents.

9.2

of which: in foreign currency

0.1

Counterpart funds

31.6

Capital accounts

471.0

Other liabilities

15.1

Total liabilities

5,237.0

Central Bank of Malaysia. Balance sheet as of December 31, 1996 Assets Gold and foreign exchange IMF reserve position Holdings of SDRs

RM 67,864,580,815 1,738,246,212 427,701,859

Malaysian Government papers

3,117,631,832

Bills discounted

1,348,188,330

Deposits with financial institutions

3,940,565,600

Loans and advances

4,659,794,797

Deferred expenditure

3,995,046,408

Other assets

9,646,762,860

Total assets

96,738,518,713

Liabilities

RM

Authorised capital RM200,000,000 Paid-up capital General reserve fund Other reserves Currency in circulation

100,000,000 2,984,193,244 42,866,826 21,065,609,098

Deposits Commercial banks, finance companies and merchant banks

49,427,350,423

Federal Government

11,107,635,451

Others

6,184,129,732

Bank Negara bills/bonds

4,967,861,569

Allocation of SDRs

505,441,566

Other liabilities

353,430,804

Total liabilities

96,738,518,713

Page 130 Central Bank of Malta. Balance sheet as of December 31, 1998 Assets Cash and bank balances

£M (thousands) 19,655

Gold

688

Placements with banks

394,500

Investment securities

173,344

IMF

40,429

Other foreign currency assets

11,357

Total external assets

639,973

Treasury bills

16,937

Domestic debts securities

17,385

Other assets

27,275

Tangible fixed assets

–5,233

Prepayments and accrued income Total assets Liabilities Notes and coins in circulation

8,188 714,991 £M (thousands) 390,912

Deposit by: Banks

115,195

Government

48,189

Others

13,367

Profit for the year payable to government

30,182

Foreign Liabilities Other Liabilities Accruals and deferred income

22,078 2,018 621,941

Other capital reserves Capital

5,000

General reserve fund

23,000

Special reserve fund

13,000

Reserves for risks and contingencies

52,050 93,050

Total liabilities and equity

714,991

Page 131 Bank of Mauritius. Balance sheet as of June 30, 1999 Assets

MRs

Capital and reserves Authorised capital

10,000,000

Issued and paid-up capital

10,000,000

General reserve fund

23,000,000 33,000,000

Other reserves

10,336,907,623 10,369,907,623

Represented by: Assets External assets: Gold and foreign assets

4,695,353,173

SDRs

537,215,154

Foreign investments

10,063,072,714

Others

19, 233,477 15,314,874,518

Discounts and advances

4,960,726,505

Government securities

1,322,424,878

Fixed assets

127,368,894

Other assets

201,753, 648

Total Liabilities Notes in circulation Coin in circulation Demand deposits: Government Commercial banks

21,927,148,443 MRs 6,615,336,230 260,677,304 6,876,013,534 41,279,522 3,447,771,728

Other financial institutions

29,269,915

Others

19,676,765 3,537,997,930

Bank of Mauritius Instruments

287,101,400

Provisions and other liabilities

856,127,956 11,557,240,820 10,369,907,623

Page 132 Bank of Mexico. Balance sheet as of September 1999 Assets International reserves

Ps (millions) 289,711

(in millions of US dollars)

31,024

Csirossr international reserves

301,112

Liabilities of less than 6 months

–11,400

Government securities

0

Credit to the federal government:

0

Credit to financial intermediaries and debtor repurchase agreements

124,998

Debtor repurchase agreements

0

Commercial banks

25,223

Development banks

156

Fobaproa

56,986

Fameval

4,590

Development trust funds Net liabilities and capital

38,043 Ps (millions)

Monetary base

127,146

Currency in circulation

127,146

Current account bank deposits Financial intermediaries deposits and creditor repurchase agreements Creditor repurchase agreements Commercial banks

0 105,552 0 84,750

Developed banks

1,648

Fobaproa

4,813

Fameval

389

Trust funds

13,951

Monetary regulation deposits

60,574.

Federal government deposits

102,830

Public sector enterprises and entities deposits IMF liabilities Other liabilities and capital, net from other assets

51,474 –32,867

Page 133 Bank of Netherlands Antilles. Balance sheet as of July 31, 1999 Assets

NAFIs (millions)

Gold and claims on the gold fund

179.8

Official reserves

416.5

Central government advance account

29.5

Other

145.8

Total assets

771.6

Liabilities

NAFIs (millions)

Capital and reserves

182.4

Banknotes

221.9

Central government receiver Island government receiver Banks Crisis fund Multi-annual plan projects Solidarity fund

1.9 (0.1) 235.8 1.0 10.2 1.0

Deposits of other residents

42.3

Other

75.2

Total liabilities

771.6

Page 134 Reserve Bank of New Zealand. Balance sheet as of June 1999 Assets

NZ$ (millions)

Denominated in foreign currency:

700

Current account advances

3,686

Marketable securities

–

IMF: holding of SDRs

–

Foreign assets Denominated in New Zealand dollars Advances: Settlement institutions

2,287

Crown settlement account

–

Advances to treasury

–

Investments in New Zealand Government securities Other

2,246 –

Fixed assets and inventories

59

Other assets

5

Total asset's

8,983

Liabilities

NZ$ (millions)

Denominated in foreign currency Current

684

Long term IMF: allocation of SDRs

4,280 –

Denominated in New Zealand dollars Reserve bank bills

–

Deposits: Government Settlement institutions Other Currency in circulation

1,556 2 26 1,897

Other liabilities

9

Capital reserves

529

Total liabilitles

8,983

Page

Page 136 Monetary Authority of Singapore. Balance sheet as of March 31, 1998 Assets and Liabilities

S$

Capital and general reserves Authorised capital

100,000,000

Issued and paid-up capital

100,000,000

General reserve fund

8,498,188,947 8,598,188,947

Represented by: Fixed assets Gold and foreign assets

102,614,349 94,341,230,306

Reserve position and holdings of SDRs in IMF

864,172,605

Other assets

526,146,552

Less:

95,834,163,812

Liabilities Deposits of banks and other financial institutions

9,959,871,287

Deposits of Singapore Government, Statutory Boards and international financial institutions Allocation of SDRs in IMF Provisions and other liabilities

59,961,257,161 35,860,165 17,278,986,252 87,235,974,865

Surplus

8,598,188,947

Page 137 National Bank of Slovakia. Balance sheet as of August 31, 1999 Assets 1 Gold 2 Deposits with IMF 2.1 In foreign currency 2.2 In slovak crowns 3 Deposits with foreign banks and international institutions in foreign currency 3.1 Deposits with foreign banks

Ks (millions) 1,206.2 31,028.5 4,908.2 26,120.3 3,717.6 3,190.4

3.2 Deposits with international institutions

527.2

4 Receivables from abroad in foreign currency

19,468.7

5 Receivables from domestic banks

29,243.6

5.1 Re-financing loans

8,797.7

5.2 Other receivables

20,445.9

6 Securities 6.1 Foreign securities in foreign currency 6.2 State securities in slovak crowns

128,833.4 117,020.1 2,935.3

6.3 Other in slovak crowns

8,878.0

7 Participations

1,632.7

7.1 Foreign participations in foreign currency

1,512.7

7.2 Other 8 Other assets

120.0 23,587.5

8.1 Customer loans

544.4

8.2 Other

23,043.1

Total assets

238,718.2

Liabilities

Ks (millions)

1 Currency issued

57,257.2

2 Liabilities to the IMF

36,706.4

2.1 In foreign currency

10,586.1

2.2 In slovak crowns

26,120.3

3 Liabilities to foreign banks and international institutions 3.1 In foreign currency. 3.2 In slovak crowns 4 Securities issued 4.1 Abroad in foreign currency 4.2 Other

30,644.0 30,149.9 494.1 13,805.1 3,805.1 10,000.0

5 Liabilities to domestic banks 5.1 Money reserve deposits of banks 5.2 Other 6 Liabilities to the state

42,997.0 40,545. 9 2,451.1 10,686.6

6.1 State account of the Slovak Republic

4055.9

6.2 Government funds

2,451.t

7 Other liabilities

10,686.6

7.1 Deposits of customers

8,000.0

7.2 Other

2,686.6

8 Net equity

18,849.6

8.1 Own capital 8.2 Other own resources Total liabiutis

10,197.7 8,651.9 238,718.2

Page 138 South African Reserve Bank. Balance sheet as of May 31, 1999 Assets Gold

R 5,993,410,874

Foreign assets

28, 311,242,532

Total gold and foreign assets

34,304,653,406

Domestic assets: loans and advances Government

590,887,392

Other

119,340,538

Accommodation to banks: Repurchase agreements Marginal lending facility Utilisation of cash reserves

7,100,000,000 0 418,775,988

Securities: Government Other Other assets

5,171,589,630 346,109,610 17,308,213,544 65,359,570,108

Rand per fine ounce Gold holdings in fine ounces Liabilities

1,512.45 3,962,717 R

Share capital

2,000,000

Reserve fund

268,207,922

Notes and coin in circulation

25,095,809,821

Deposits: Government

296,724,951

Banks

14,231,008,544

Other

306,353,681

Other liabilities

25,159,465,189 65,359,570,108

Page 139 Bank of Spain. Balance sheet as of December 31, 1998 Assets

Pta (billions)

Foreign assets

8,677

State

1,721

Other public sector accounts

306

Credit to financial institutions

4,471

Investment securities

688

Premises and equipment

38

Bills and other rights receivable

73

Sundry accounts

129

Accrual accounts

128

Total assets

16,231

Liabilities

Pta (billions)

Bank of Spain nationalisation capital

–

Reserve funds

1,794

Notes in circulation

8,774

SDRs assigned Foreign liabilities State

60 9 1,709

Independent government agencies

447

Other public sector accounts

148

Accounts payable to financial institutions Accounts payable to other agents Bills and other obligations payable

2,359 3 98

Sundry accounts

103

Income pending payment to the treasury

701

Accrual accounts Total liabilities

26 16,231

Page

Page 140 Bank of Sweden. Balance sheet as of June 30, 1999 Assets Cash and credit balances at central banks In Skr In other currencies Treasury bills, etc, eligible for central bank refinancing In Skr In other currencies

Skr (millions) 22,507 14,445 8,062 170,022 129,224 40,798

Lending In Skr In other currencies Riksbank Swedish banks In Skr In other currencies Swedish housing credit institutions In Skr In other currencies Other Swedish credit market companies etc In Skr

1,195,141 438,995 2,711 97,947 95,325 2,623 183,591 182,450 1,141 61,101

Page 141 Bank of Sweden. Balance sheet as of June 30, 1999 Liabilities Liabilities/deposits and borrowing In Skr In other currencies Riskbank

Skr (millions) 1,635,507 1,109,305 526,202 38,176

Swedesh banks

106,419

In Skr

103,356

In other currencies Swedish housing credit institutions In Skr1 In other currencies Other Swedish credit market companies, etc In Skr In other currencies Foreign financial institutions

3,063 17,264 17,080 184 12,297 5,577 6,720 460,688

In Skr

118,840

In other currencies

341,848

Of which: Banks

452,829

Swedish National Debt Office

1,101

Swedish social insurance funds

2,542

Swedish insurance companies

48,854

Swedish securities companies

12,650

Swedish non-bank sector In Skr

772,682 740,483

In other currencies

32,199

Local authorities

18,791

Non-financial enterprises

261,654

Households including unincorporated businesses

434,366

In Skr

433,420

In other currencies Other Swedish non-bank sectors Foreign non-bank sector, etc In Skr In other currencies :

946 57,871 162,835 27,475 135,360

Securities, etc, issued

256,706

CDs

166,983

Bonds

86,787

Others

2,935

Other liabilities Accrued expenses and prepaid income Provisions

383,028 37,021 1,834

Subordinated liabilities

71,523

Subordinated loans

71,375

Other

149

Untaxed reserves

22,395

Equity

41,977

Other funds

21, 308

Profit or loss brought forward

19,073

Net income and expenditure Total liabilities and equity In Skr

6,656 2,497,029 1,581,306

In euro and EMUcurrencies

179,771

In other EU currencies

123,503

In other currencies

612,450

Assets pledged as collateral for own liabilities

164,879

Assets pledged, other

44,065

Contingent liabilities

168,425

Commitments

328,439

Page 142 Swiss National Bank. Balance sheet as of December 31, 1998 Assets

Sfr (millions)

Gold holdings and claims from gold transactions Gold holdings

11,045.5

Claims from gold transactions

884.6

Foreign currency investments Not exchange-rate hedged

45,005.7

Exchange-rate hedged (swaps)

7,800.1

Reserve position in the IMF

3,070.6

International payment instruments

390.8

.Balance of payments aid

768.3

Claims from Swiss franc Repo transactions Domestic money market claims

17,348.3 –

Lombard advances

0.3

Claims against domestic correspondents

378.8

Domestic securities

5,010.0

Participations

89.4

Tangible assets

563.0

Sundry assets

480.4

Non paid-up share capital

25.0

Total assets Liabilities

92,860.7 Sfr (millions)

Banknote circulation;

33,218.8

Sight deposit accounts of domestic banks

6,860.1

Liabilities towards the Confederation Sight

147.6

Time

14,972.0

Sight deposit accounts of foreign banks and institutions

163.5

Other Sight liabilities

236.1

Liabilities from Swiss franc Repo transactions

–

Foreign currency liabilities

175.9

Sundry liabilities..

265.3

Provisions For market credit and liquidity risks

34,728.6

For operating risks

471.7

Share capital

50.0

Reserve fund

63.0

Net disposable Income–annual profit Total liabilities

1,508.0 92,860.7

Page 143 Bank of Thailand. Balance sheet as of June 25, 1999 Key components of the Bank of Thailand's assets and liabilities 1 International reserve (billions of US $)

31.4

2 Net forward position (billions of US $)

–3.4

3 Net claims on government (billions of baht) 3.1 Government bonds held by FIDF (billions of baht) 4 Net claims on financial institutions (billions of baht) 5 Reserve money (billions of baht)

125.2 69.1 69.1 414.3

Definitions: International reserve = Gold foreign exchange + SDRs + reserve position in the IMF Net forward position = Bank of Thailand's forrward obligations to buy (4) or sell (–) foreign currency against Thai Baht Net claims on Government = Bank of Thailand's lending to Government less Government's deposits at the Bank of Thailand and currency held by Government Net claims on financial institutions = Bank of Thailand's lending to financial institutions less Bank of Thailand's borrowing from financial institutions Reserve money = Notes and coins in circulation plus deposits of financial institutions

Central Bank of Turkey. Balance sheet as of December 31, 1998

Assets

Amount of Turkish currency accounts (TL)

Amount of foreign currency accounts (TL)

Total of Turkish currency accounts (TL)

I Gold (A) International St (net grams) 116,589,408.70 8,820,620,640,000

(B) Non-international St (net grams) 3,249,293.82 II Foreign exchange (A) Convertible (a) Foreign bank notes

147,588,229,735,500

(b) Correspondent accounts

6,019,556,440,050,000

(B) Non-convertible 346,336,032,500

(a) Foreign banknotes (b) Correspondent accounts

39,439,933,000

III Coins

787,403,779,800

IV Domestic correspondences

549,458

V Securities portfolio (A) Government securities (a) Bonds

1,261,402,261,293,000

(b) Treasury bills

1,124,362,406,473,000

(B) Other

2,385,764,667,766,000 25,000,000,000

VI Domestic credits (A) Public sector (a) Treasury (i) Short-term advances to the treasury (ii) Other (net) (b) Public economic institutions (i) Commercial (c) State economics enterprises (i) Treasury guaranteed bills (ii) Commercial bills (iii) Others

1,559,260,244,740

(B) Banking sector (a) Commercial (i) Export (ii) Other (b) Agricultural (i) Agricultural credit co-operatives

7,539,099,657,000

1,559,260,244,740

(ii) Unions of agricultural sales co-operatives (iii) Other

Central Bank of Turkey. Balance sheet as of December 31, 1998 (continued)

Assets

Amount of Turkish currency accounts (TL)

Amount of foreign currency accounts (TL)

Total of Turkish currency accounts (TL)

(c) Industrial (d) Advances against bond collactors 7,539,099,657,000

(e) Other IV Open market operations (A) Repurchase agreement (a) Cash (i) Foreign exchange (ii) Securities

1,587,950,872,422,500 1,587,950,872,422,500

(b) Securities (B) Others

242,640,000,000,000

VIII Foreign credits IX Share participations X Fixed assets (A) Building and building sites

25,791,139,011,014

Depreciation allowance for real estate

(1,865,548,955,614)

(B) Furniture and fixtures Depreciation allowance for furniture and fixtures XI Claims under legal proceedings

23,925,590,055,400

7,767,031,748,217 (2,603,815,561,784)

5,163,216,186,433 4,825,560,700

XII Consolidated claims and foreign exchange revaluation differences (A) Claims under consolidation law (B) Revaluation differences as per Artical 61 of the Central Bank's law (a) Liquidated (b) To be liquidated XIII Miscellaneous receivables XIV Other assets Total Regulating accounts

78,076,237,376,867 115,993,464,816,412 4,458,250,259,055,310

Central Bank of Turkey. Balance sheet as of December 31, 1998

Liabilities

Amount of Turkish currency accounts (TL)

Amount of foreign currency accounts (TL)

Total of Turkish currency accounts (TL) 1,328,542,400,922,800

I Currency issued II Liabilities to treasury (A) Gold 345,574.68

938,106,346,000

(B) Other (net)

60,004,256,989,214

III Foreign correspondents (A) Convertible (B) Non convertible IV Deposits (A) Public sector (a) Treasury, general and annexed budget administration

212,895,263,642,458

518,793,644,405,500

(b) Public economic institutions

14,114,214,550

(c) State economic enterprises

22,182,792,784

921,112,296,500

15,977,858,185,969

41,211,829,000

88,190,356,329,574

421,501,542,846,500

(d) Other

228,909,418,835,761

(B) Banking sector (a) Free deposits of domestic banks (b) Foreign banks

134,605,016,243

(c) Required reserves (Central Bank law, Article 40) (i) Cash

694,261,368,694,000

953,759,501,319,000

(ii) Gold (net g) (d) Other

782,586,330,039,817

(C) Miscellaneous (a) Foreign exchange deposits by citizens abroad (b) Other

4,005,515,931,389,000 2,032,904,164,338

2,982,549,587,500

(D) International Institutions

2,032,904,164,338 2,063,501,585,786

(E) Extra-bugetary funds (a) Saving deposits insurance fund

6,686,758,000

124,064,789,231,500

16,547,215,315,844

(b) Other V Open market operations (A) Repurchase agreements (a) Cash (i) Foreign exchange (ii) Securities (b) Securities (B) Other VI Foreign credits

1,557,599,954,905,500

1,557,599,954,905,500

(A) Short-term

Central Bank of Turkey. Balance sheet as of December 31, 1998 (continued)

Liabilities

Amount of Turkish currency accounts (TL)

Amount of foreign currency accounts (TL)

Total of Turkish currency accounts (TL)

(B) Medium- and long-term VII Advances, collateral and deposits collected against letters of credit and import (A) For letters of credit 4,324,512,046

(B) For import VIII Notes and remittances payable

255,698,500

IX Capital

25,000,000,000

X Reserves 63,403,227,526,500

(A) Ordinary and extraordinary reserves (B) Special reserves (Central Bank's law, Article 59)

8,756,311,685

(C) Reserve for future losses (Article 32 of Banking Laws

25,000,000,000,

(D) Valuation adjustment fund (Laws 2791 and 3094)

22,229,512,363,396

(E) Cost adjustment fund

34,747,988,535

XI Provisions

1,957,865,840,300

XII Foreign exchange revaluation differences (A) Revaluation difference as per Article 61 of Central Bank Law) (a) Liquidated (b) To be liquidated XIII Miscellaneous payables

499,635,979,046,750

499,635,979,046,750 2,130,737,509,790

XIV Other liabilities

519,396,211,213,778

XV Profit

298,423,646,279,970

Total Regulating accounts

5,386,499,353,496,310

Page 148 Bank of England. Balance sheet as of February 28, 1999 Assets

£ (millions)

Cash

8

Item s in course of collection

217

Treasury and other eligible bills

18

Due from central banks in respect of target

7,949

Loans and advances to banks, the money market and customers

7,773

Debt securities

3,715

Equity shares and participating interest

26

Shares in group undertakings.

18

Tangible fixed assets

353

Prepayments, accrued income and other assets

316

Total assets Liabilities

20,393 £ (millions)

Due to central banks in respect of target

7,349

Deposits by central banks

2,187

Deposits by banks and building societies

1,890

Customer accounts

7,280

Other liabilities

398 19,104

Capital Revaluation reserves

15 239

Profit and loss account

1,035

Shareholders' funds

1,289

Total liabilities

20,393

Page 149 Federal Reserve Bank of New York. 1998 Annual Report. Balance sheet as of December 31, 1998 Assets

US$ (millions)

Gold certificates

4,206

SDRs certificates

3,202

Coin

15

Items in process of collection Loans to depository institutions

745 –

US government and federal agency securities, net

201,503

Investments denominated in foreign currencies

4,002

Accrued interest receivable

1,965

Inter-district settlement account

–

Bank premises and equipment, net

241

Federal Reserve System prepaid pension benefit cost

1,491

Other assets Total Liabilities Federal Reserve notes outstanding, net

54 217,424 US$ (millions) 194,182

Deposits: Depository institutions

7,533

US Treasury, general account

6,086

Other deposits

164

Deferred credit items

810

Surplus transfer due US Treasury

373

Inter-district settlement account Accrued benefit cost

5,656 151

Other liabilities

53

Total liabilities

215,008

Capital Capital paid-in

1,208

Surplus

1,208

Total capital

2,416

Total liabilities and capital

217,424

Page 151

Appendix C— IMF Strengthens Standards for Public Dissemination of Data on International Reserves Background The IMF has taken action to strengthen the specifications for dissemination of data on international reserves under its Special Data Dissemination Standard (SDDS). The strengthening of the SDDS is part of the ongoing efforts to improve the architecture of the international financial system. Recent financial crises have underscored the importance of more comprehensive and timely information on international reserves, to help promote informed decision-making in the public and private sectors and thereby improve the functioning of global financial markets. The proposals for reserves data under the SDDS were developed in response to guidance from the IMF Interim Committee. They are intended to establish new standards for the provision of information to the public on the amount and composition of reserve assets, other foreign exchange assets held by the central bank and the government, short-term foreign liabilities, and related activities that can lead to demands on reserves (such as financial derivatives positions and guarantees extended by the government for private borrowing). The reserves data template, spelling out the information to be provided, reflected the experience in member countries, the results of two previous Executive Board discussions, and comments received through consultations with data users in the public and private sectors and statistical compilers. From the outset, there was widespread interest in increasing transparency in this area. However, many Fund members have expressed concerns about the resource costs of compiling and disseminating more detailed, frequent, and timely data and the possibility that this would reduce the effectiveness of exchange market intervention operations. The final decisions reflected a balancing of these objectives and concerns. The template was finalised in co-operation with a working group of the Committee on the Global Financial System of the Group of Ten central banks. The G10 central banks have also adopted the template for use in the data dissemination activities of that Committee. The template is included here, and copies also may be found on the websites of the IMF (www.IMF.org) and the BIS (www.bis.org). The SDDS is a standard of good practices in the dissemination of economic and financial data, to which IMF member countries may subscribe on a voluntary basis. It is intended for use mainly by countries that either have or seek access to international financial markets, to signal their commitment to the provision of timely and comprehensive data. As of March 1999, there were 47 subscribers to the SDDS. Executive Board Discussion Executive directors welcomed the revised staff proposals to strengthen the prescriptions for the international reserves data category under the SDDS. In particular, directors appreciated that the revised proposals represented an attempt to balance the objective of strengthening reserves data dissemina-

Page 152

tion against concerns about the costs of observing the new standards and the confidentiality of information on intervention operations. In commenting on the reserves data template, a few directors regretted that the template did not contain as much information as the initial staff proposals in December 1998. Some other directors suggested that the degree of detail being requested, particularly on reserve-related liabilities and other potential drains on reserves, was still excessive. On the whole, however, most executive directors were satisfied that the template provided a good basis for efforts to enhance the availability to the public of more frequent, timely and comprehensive information on reserves and related items. Most directors considered that recent international financial crises demonstrated the importance of disseminating information on reserves and related items with a short lag and a relatively high frequency. In that context, several directors noted that publication of reserves data on a weekly basis, with a lag of only a few days, had become increasingly common among emerging market countries active in international capital markets; these directors encouraged other members to follow such practices. However, since the reserves template called for much more detailed data, many directors also stressed that there would be a need for countries to adapt their internal reporting systems to generate the information needed under that template. Several directors suggested that more consultation on the template, particularly with developing countries, would be useful. Directors looked forward to the completion of the operational guidelines for compilers after the Spring Meetings. They also considered that it was appropriate for the SDDS prescriptions for the periodicity and timeliness of data dissemination in connection with the new template to be well balanced and to reflect the consensus among members. In that context, most directors agreed that the SDDS prescription should be for dissemination of full data corresponding to the new template on a monthly basis, with a lag of no more than one month, although data on total reserve assets would still be prescribed for dissemination on a monthly basis with a lag of no more than one week. The dissemination of data for the full template on a weekly basis, with a one-week lag, was to be encouraged. This proposal is therefore adopted. Bearing in mind the advantages of more frequent and timely data, as well as the concerns of some members about the costs of disclosure, directors agreed that the prescriptions for the periodicity and timeliness of reserves data dissemination should be reassessed in the context of the Third Review of the SDDS, around the end of 1999. A few directors were of the view that the issue of periodicity and timeliness should be revisited after sufficient experience had been accumulated under the enhanced SDDS and more progress made in addressing the issue of symmetry in data dissemination between the public and private sectors. Directors indicated that the transition period for observance of the new standards should be through March 31, 2000. Executive directors were generally satisfied that it had been possible to reach conclusions on this matter. At the same time, a number of directors noted that the SDDS prescriptions for reserves data were a minimum standard which many members already exceeded. They underscored their hope that for such countries the present decision would not lead to any reduction in the frequency, or increase in the lag, in reporting, or a reduction in the quality of data. Many directors stressed that it would be important for efforts to strengthen the dissemination of information on public sector financial operations to be accompanied by improvements in the availability of information on the activities of private institutions in international financial markets.

Page 153

Public Information Notices Public Information Notices (PINs) are issued: (1) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (2) following policy discussions in the Executive Board at the decision of the Board. Data Template on International Reserves/Foreign Currency Liquidity This information is to be disclosed by the monetary authorities and other central government, excluding social security. I— Official Reserve Assets and Other Foreign Currency Assets (Approximate Market Value) A. Official reserve assets 1. Foreign currency reserves (in convertible foreign currencies) (a) Securities of which: issuer headquartered in reporting country (b) total deposits with: (i) other central banks and BIS (ii) banks headquartered in the reporting country of which: located abroad (iii) banks headquartered outside the reporting country of which: located in the reporting country 2. IMF reserve position 3. SDRs 4. Gold (including gold on loan) 5. Other reserve assets (specify) B. Other foreign currency assets (specify) II— Predetermined Short-Term Net Drains on Foreign Currency Assets (Nominal Value) Maturity breakdown (residual maturity) 1. Foreign currency loans and securities 2. Aggregate short and long positions in forwards and

Total

Up to 1 month

More than 1 month and up to 3 months

More than 3 months and up to 1 year

futures in foreign currencies vis-à-vis the domestic currency (including the forward leg of currency swaps) (a) Short positions (b) Long positions 3. Other (specify)

Page 154

III— Contingent Short-Term Net Drains on Foreign Currency Assets (Nominal Value) Maturity breakdown (residual maturity, where applicable) 1. Contingent liabilities in foreign currency (a) Collateral guarantees on debt falling due within 1 year (b) Other contingent liabilities 2. Foreign currency securities issued with embedded option (puttable bonds) 3. Undrawn, unconditional credit lines (a) With other central banks (b) With banks and other financial institutions headquartered in the reporting country (c) With banks and other financial institutions headquartered outside the reporting country 4. Aggregate short and long positions of options in foreign currencies vis-à-vis the domestic currency (a) Short positions (i) Bought puts (ii) Written calls (b) Long positions (i) Bought calls (ii) Written puts Pro memoria: In-the-money options (1) At current exchange rates (a) Short position (b) Long position (2) +5% (appreciation of 5% of the domestic currency) (a) Short position

Total

Up to 1 month

More than 1 More than 3 month and up to 3 months and up to months 1 year

(b) Long position (3) –5% (depreciation of 5% of the domestic currency) (a) Short position (b) Long position (4) +10% (a) Short position (b) Long position (5) –10% (a) Short position (b) Long position (6) Other (specify)

Page 155

IV— Memo items 1. To be reported with standard periodicity and timeliness: · short-term domestic currency debt indexed to the exchange rate; · financial instruments denominated in foreign currency and settled by other means (eg, in domestic currency); · pledged assets; · securities lent and on repo; · financial derivative assets (net, marked to market); and · derivatives (forward, futures, or options contracts) that have a residual maturity greater than one year, which are subject to margin calls. 2. To be disclosed less frequently (eg, once a year): · currency composition of reserves (by groups of currencies). Notes 1. In principle, only instruments denominated and settled in foreign currency (or those whose valuation is directly dependent on the exchange rate and that are settled in foreign currency) are to be included in categories I, II and III of the template. Financial instruments denominated in foreign currency and settled in other ways (eg, in domestic currency or commodities) are included as memo items under Section IV. 2. Netting of positions is allowed only if they have the same maturity, are against the same counterparty, and a master netting agreement is in place. Positions on organised exchanges could also be netted. 3. Monetary authorities defined according to the IMF Balance of Payments Manual, 5th edition. 4. In cases of large positions vis-à-vis institutions headquartered in the reporting country, in instruments other than deposits or securities, they should be reported as separate items. 5. The valuation basis for gold assets should be disclosed; ideally this would be done by showing the volume and price. 6. Including interest payments due within the corresponding time horizons. Foreign currency deposits held by non-residents with central banks should also be included here. Securities referred to are those issued by the monetary authorities and the central government (excluding social security). 7. In the event that there are forward or futures positions with a residual maturity greater than one year, which could be subject to margin calls, these should be reported separately under Section IV. 8. Only bonds with a residual maturity greater than one year should be reported under this item, as those with shorter maturities will already be included in Section II, above. 9. Reporters should distinguish potential inflows and potential outflows resulting from contingent

lines of credit and report them separately, in the specified format. 10. In the event that there are options positions with a residual maturity greater than one year, which could be subject to margin calls, these should be reported separately under Section IV. 11. These ''stress-tests" are an encouraged, rather than a prescribed, category of information in the IMF's Special Data Dissemination Standard (SDDS). These could be disclosed in the form of a graph. As a rule, notional value should be reported. However, in the case of cash-settled options, the estimated future inflow/outflow should be disclosed. Positions are "in-the-money" or would be, under the assumed values. 12. Distinguish between assets and liabilities where applicable. 13. Identify types of instrument; the valuation principles should be the same as in Sections I–I1I. Where applicable, the notional value of non-deliverable forward positions should be shown in the same format as for the nominal value of deliverable forwards/futures in Section II. 14. Only assets included in Section I that are pledged should be reported here. 15. Assets that are lent or reposed should be reported here, whether or not they have been included in Section I of the template, along with any associated liabilities (in Section II). However, these should be reported in two separate categories, depending on whether or not they have been included in Section I. Similarly, securities that are borrowed or acquired under repo agreements should be reported as a separate item and treated symmetrically. Market values should be reported and the accounting treatment disclosed. 16. Identify types of instrument. The main characteristics of internal models used to calculate the market value should be disclosed.