International reserves and the government
The level of international reserves of the country has attained the highest level ever, reaching $5.2 billion by the end of August. Many regard it as a good omen for the economy, but others are more circumspect. A well-known business leader asked me why the government was unnecessarily building up such large international reserves; should it not instead use part of the reserves to assist industries that were smarting under the forces of global competition and multifarious domestic constraints! These questions could be directed perhaps more usefully to Bangladesh Bank or the Ministry of Finance, who are in a better position to assuage the concerns of the business people. Actually such sentiments have been publicly expressed from various quarters for quite some time now, but the relevant authorities did not, for whatever reasons, allay their anxieties. The aforementioned business leader, and many others, mistakenly credit the government with building up international reserves, but it has actually very little to do with the reserves directly. On the contrary, the business sector and the expatriates are the principal driving forces in this respect. International reserves are the holdings of foreign liquid assets including foreign exchange by Bangladesh Bank and the commercial banks. These are accrued through running surpluses in the balance of payments; an increase in the reserves is a reflection of the excess of receipts of foreign exchange over payments. To the extent government activities give rise to foreign exchange transactions, such as the purchase of defence equipment or acquiring aid, the government has some direct influence on the level of international reserves. The liberalisation of the economy since the late eighties has reduced such influence, and it will no doubt erode further in the future. This is not to deny that the government can have significant influence on international reserves indirectly through economic policies that affect flows of international transactions. For example, if it adopts policies that actually encourage large inflows of foreign investment or promote exports of goods, services and labour, international reserves will swell up fairly quickly. But this increase in reserves will manifest itself only in the activities of private business (local and foreign), and not government transactions. Hence, it is not justified to credit the government with directly contributing to the accumulation of international reserves. Second, the level of international reserves held by Bangladesh Bank is anything but "large." Indeed it is not even high relative to its level during the first half of the 1990s. Reserves are a buffer against foreign exchange payments, especially imports. Hence, the adequacy or the level of the reserves is best expressed in terms of weeks or months of import requirements. The absolute level is misleading since the absolute requirements of foreign exchange also increase over time as the national economy grows. The chart below shows that the level of international reserves expressed in terms of months of imports in the mid-nineties was almost twice the level it is today. There is no upper limit to the level of international reserves that a country may hold. It is the final outcome of the complex forces that determine the balance of payments and economic policies of a country. India had international reserves of only one and half billion dollars at the beginning of the 1990s, but now it has in excess of $266 billion. China has increased its reserves from less than two billion dollars in the late 1970s to more than 1.4 trillion dollars now! Bangladesh actually holds the lowest reserves in the subcontinent. India's reserves can support import payments of about 16 months, while Pakistan now has reserves equivalent to more than 6 months' import payments. Bangladesh had reserves equal to only 2.8 months' imports in 2005-06 that rose to 3.6 months' imports in 2006-07. There are some risks when international reserves fall to a low level. Low reserves reduce the ability of the central bank to operate or intervene in the exchange market thus reducing its effectiveness in cushioning the economy against any adverse shocks. Low reserves could also undermine market confidence in the domestic currency, which could lead to a run on, and a sharp depreciation of, the currency. Sharp fluctuations in the value of the currency impact adversely on the balance of payments as well as on the economy as whole. The Asian financial crisis a decade ago is a good example of what a run on the domestic currency can do. However, there are no accepted rules regarding the minimum level of reserves. The government regards reserves equivalent to 3-4 months import payments as adequate. Others suggest that the country should hold reserves equivalent to at least six months' import payments as buffer to ensure orderly functioning of the exchange market. This level was achieved during the first half of the nineties, and can be achieved again with correct policies. Finally, quite contrary to the general belief, the government does not own international reserves, and hence, cannot use it to finance its programs. It impacts on international reserves essentially in the same manner as the business sector does. It can purchase or borrow foreign exchange to finance its transactions just as a business enterprise can do. If the nation needs to import one million tons of rice to offset the flood damages, the impact on the international reserves will be the same regardless of who, the government or the private sector, imports the rice. The government must take decisions about fiscal expenditures, including industry assistance, on the basis of its broader economic goals and budgetary constraints. The size of the reserves should not be a major consideration in the decision-making process unless a large amount of foreign currency payment is involved. With correct policies put in effect, the economy should undergo adjustments that maintain the balance of payments at a comfortable position. The author is a Professor of Economics, University of Dhaka.
For all latest news, follow The Daily Star's Google News channel.
Comments