Accumulation of International Reserves in Middle East and East Asian Countries
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Accumulation of International Reserves in Middle East and East Asian Countries

Explains the main causes of international reserves accumulation in Middle East and East Asian countries.

Having realized the importance of increased liquidity as a form of (self) protection against crises, many developing countries (i.e. Middle East and East Asian) started to accelerate their accumulation of international reserves. Chart 1shows the increase of such accumulation.

Having international reserves enables economies to adopt slower speeds of adjustment when confronted with balance of payment crises, contributing to their perceived creditworthiness and hence reducing the occurrence of crises: higher reserves mean that future out may be avoided since future current account deficits can be better financed, and the effects of capital outflows can be neutralized by running down reserves. (Bird & Mandilaras 2005)

According to Bird & Mandilaras (2005), the view (from the U.S Congress and the Meltzer Commission) was that the IMF (International Monetary Fund) by lending too much (e.g. enticing private markets to over lend) could create a moral hazard problem. Thus, after the Asian financial crisis Asian countries were advised to build up their international reserves as way of reducing risks of future crisis, and minimizing the need to turn to the IMF if such crisis occurred.

As a result, many (East) Asian economies accumulated reserves by means of running current account balance of payments surpluses. Data in Tables 1 and 2 show the extent which Asian economies have run current balance of payments surpluses and accumulated international reserves since the Asian financial crisis; also showing that net capital inflows have (frequently) allowed the reserve accumulation to exceed the account surplus.

Another cause for accumulation of reserves is the indirect consequence of other policies. For example, in order to encourage export-led growth, governments (i.e. China) may set out to defend undervalued exchange rates. While currency undervaluation generates export growth, as long as the policy is maintained, it will discourage imports and generate current account balance of payments surpluses and reserves will tend to build up.

Lastly, for both of Middle East (and East Asian) economies, involving the IMF and being subjected to its conditionality would result in a loss of national sovereignty over policy (i.e. might become more risk adverse instead), as opposed to the perceived benefits of holding reserves, leading to accumulation of international reserves in these countries.

References:

  • Bird, G, Mandilaras, A, 2005, ‘Reserve Accumulation in Asia’, World Economics 6, no. 1, pp 85-99.
  • Carbaugh, R J, 2009, International economics, 12th edn, South-Western Cengage Learning, USA
  • IMF, viewed 15 April 2010, <http://www.imf.org>

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