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Optimal level of reserves

Optimal level of reserves . XXIV Meeting of the Latin American Network of Central Banks and Finance Ministries Adrián Armas. Washington , October 20 2006. Reasons for accumulating international reserves. Lack of an international lender of last resort.

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Optimal level of reserves

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  1. Optimal level of reserves XXIV Meeting of the Latin American Network of Central Banks and Finance Ministries Adrián Armas Washington, October 20 2006

  2. Reasons for accumulating international reserves • Lack of an international lender of last resort. • Negative experiences with privately funded liquidity insurance • Pooling of reserves

  3. Some facts about the pooling of reserves • There are some issues to evaluate: • Possible simultaneity in the demand for resources • Resources used to constitute the pool maynot be considered as high quality assets. • Differences in economic size among countries can generate problems of resource allocation

  4. If potential members of a reserve pool face symmetric shocks, there could be a simultaneous demand for resources. Shocks in the real sector seems not to be highly correlated

  5. However, correlation among spreads can signal some potential simultaneity in the demand for resources

  6. Optimal level of international reserves • An adequate level of international reserves can be used as a self insurance during financial turmoil. • According to the literature on financially dollarized economies, a higher degree of dollarization increases the vulnerability of the financial system to liquidity and solvency risks. • Gulde et al (2004) point out that it is harder to deal with a bank run in a highly dollarized economy, because it is subject to more risk.

  7. Fiscal deficit1997 – 2006(as percentage of GDP) 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006* * June (last 4 quarters)

  8. Public debt1999 – 2006(as percentage of GDP) * June

  9. Even though dollarization indicators in Peru show a decreasing trend over the last few years, financial dollarization is still high Financial dollarization indicators 2006* * August

  10. Financial dollarization risks

  11. Net international reserves1997- 2006(in billions of US$) * * September

  12. Peru’s reserve adequacy ratio is higher than other countries of the region 2/ Indicators calculated for 2005. Source: Moody’s Statistical Handbook. Country Credit. May 2006

  13. International liquidity indicators should also consider financial dollarization risks 1/ NIR as of September 30, imports as of August 31 and short term external liabilities as of June 30.

  14. Foreign exchange interventionJanuary 2002 – September 2006 Brasil, 2002 Peru, presidential elections Precautionary accumulation of reserves

  15. Risks in reserve accumulation CDBCRP balances relative to credit to the private sector Percentage Billions of US$

  16. Risks in reserve accumulation CDBCRP balances and average interest rate of CDBCRP: 2003- 2006 Millions of S/. Percentage

  17. Risks in reserve accumulation Average interest rate of CDBCRP and 3 month LIBOR Percentage

  18. Conclusions • During 2003-2005, the BCRP has accumulated NIR with the objective of being in a better position to face negative shocks that could be amplified due to financial dollarization. • Foreign exchange intervention and NIR accumulation have been consistent with the Inflation Targeting framework in a dollarized economy. In particular: a. Inflation target has been met since IT adoption. b. Sterilized intervention have kept interest rates in line with the interbank reference rate.

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