Foreign exchange reserves in a credit constrained economy

Abstract

We discuss the role of foreign exchange reserves as precautionary savings under an imperfect market framework due to the presence of endogenously determined borrowing constraints. We show that cost of holding reserves is higher in borrowing constrained economies than unconstrained ones as a result of the leverage e¤ect of the debt. We also argue that high global reserve holdings can even be welfare reducing for the world economy where …nancially constrained developing countries are heavy borrowers in international lending markets.JEL Classi…cation: F32, F34.

A robust examination of COVID‐19 and country risk: Perspectives from the G10 countries

“…In terms of growth rate of international reserves, the results in Table 5 show that the growth rates of COVID-19 have affected the growth rate of international reserves positively; an immediate governmental procedure to keep an economy functioning as much as possible. This result supports the results reported by Akdogan (2012) explained in his study that although reserves act as hedge against financial vulnerabilities in emerging economies and reduces the risk premium. However, in developed economies, the reserve accumulation is costly because those funds could have been channeled to less liquid but more productive investments.…”

“…Caballero and Panageas (2008) argue that when a country builds up a reserve, it may turn out to be a costly option especially if the reserve is associated with financial constraints and obligations. The same argument is made by Akdogan (2012) that the cost of maintaining reserves may turn out to be high as well if a country is constrained by international credit. The quantity of net worth offered as collateral determines how much a financially constrained economy can borrow.…”

Bangladesh's foreign exchange reserves: A comparative study with key South Asian economies

“…The International Monetary Fund (IMF) states that sufficient reserves may alleviate the impact of external disturbances, instill market confidence, and guarantee a nation's financial stability (IMF, 2021) [13] . Reserves are critical for developing countries, such as Bangladesh, because they are more vulnerable to the hazards of unpredictable changes in capital flows and foreign trade (Akdoğan, 2012) [2] . Bangladesh has made remarkable strides in terms of economic development over the past several decades.…”

Bank lending in an emerging economy: How does central bank reserve accumulation matter?

“…It is found that during the global financial crisis, countries holding considerable foreign reserves may well circumvent exchange rate depreciations (Aizenman & Hutchison, 2012). Similarly, the central banks' foreign reserve holdings may improve market liquidity and cushion liquidity shocks that can hurt the financial market (Akdoǧan, 2012). In a longstanding view, increased foreign exchange reserves allow the central bank to have wider and stronger interventions, thereby leaving the money supply unaffected and causing little effect on the exchange rate (Sarno & Taylor, 2001).…”