The domestic financial consequences of reserve accumulation: some evidence from Asia

December 2008


Between 2002 and 2006, official reserves in Asia grew at an unprecedented rate, mainly as a by-product of official efforts to resist currency appreciation. Apart from the external adjustment and international political repercussions, the policy of resisting appreciation ran the domestic risks of inflation, financial instability and central bank losses. This paper examines the evidence for these domestic financial consequences. We find that, through 2006, the evidence was not strong for the proposition that the economies that had accumulated most reserves had suffered the greatest inflation or increase in banking system risk. As for central bank losses, these had become evident precisely in the economies that had permitted most appreciation, though only time will tell where they will prove largest. In this period in Asia, the policy of resisting appreciation generally responded to a situation in which investment demand remained weak in relation to savings. Such initial conditions may have muted the adverse domestic consequences of the policy of sustained resistance to appreciation.

The complete paper is published in the book: "Exchange rate, monetary and financial issues and policies in Asia".