International Reserves
International reserves are defined by the International Monetary Fund (IMF) as assets held by a country’s government or central bank which are “freely usable” – that is, capable of being used to make international payments and finance transactions. In other words, international reserves consist of foreign currency deposits, securities and other financial claims on foreign institutions – all of which are held by a country’s central bank.
While the vast majority of international reserves are held in U.S. Dollars, the IMF also recognizes reserves held in euros, yen, pounds sterling and a handful of other currencies. A country’s international reserves can also include its holdings of gold and Special Drawing Rights (SDRs) administered by the IMF.
International reserves are important for a country to be able to maintain the relative stability of its national currency, and perform its international payments obligations, including repayment of its external debt, in a timely manner. Without sufficient international reserves, a country could be at risk of defaulting, or being forced to impose austerity measures that could hurt economic growth.
The use of international reserves also stabilizes exchange rates and protects against sudden capital outflows. Most central banks in the world have policies in place limiting currency outflows, and when exchanges rates become too volatile or their own currency depreciates too rapidly, central banks can intervene by selling international reserves and buying domestic currency – which can help stabilize the exchange rate.
The size of a country’s international reserves is determined by its current account balance and the amount of short-term external debt that it must finance. A country with a current account surplus is likely to have larger reserves than a country with a current account deficit. As a general rule of thumb, the level of international reserves should be equal to at least three months of imports, although there is no hard and fast rule.
International reserves are typically kept in high quality, liquid investments such as U.S. Treasury securities and certain bank deposits. Central banks usually utilize specialized custodial services and asset managers to manage and store their reserves.
In addition to managing and maintaining its reserves, a country’s central bank also has the important role of acting as lender of last resort, in the event of an emergency financial crisis. By deploying its reserves, a central bank can help ensure that the banking system and economy of a country do not come to a standstill due to an acute shortage of liquidity.
International reserves can also be used for other purposes such as providing liquidity to foreign investors and supporting additional borrowing for foreign investments. Countries with large international reserves will often have an easier time accessing international capital markets and raising funds for projects and investments.
Overall, international reserves are essential for any nation seeking financial stability, smooth payment of foreign obligations, and to protect its citizens from financial shocks. Having a healthy reserve of foreign currency can also allow a country to have more control over its economy, providing some degree of resilience during times of global economic turbulence.
Therefore, for any country to remain financially stable and to be able to compete in the global economic environment, it is vital to maintain an adequate level of international reserves.
