Global reserves management Government Borrowers Forum 2007 Montreal, Canada 16 May 2007

1. Global reserves managementGovernment Borrowers Forum 2007 Montreal, Canada16 May 2007 Dr Krzysztof Rybiński* National Bank of Poland Deputy Governor Email: krzysztof.rybinski@nbp.pl Blog: www.rybinski.eu *Views presented here are my own and they do not necessarily represent the official position of the National Bank of Poland or the Polish Financial Services Authority. Paper published in September 2007 in Economista (in English)

2. Research motivation • Central banks reserves exceeded 5 trillion dollars in 2006, SWFs hold at least 1.5 trillion dollars, cumulative reserves holding forecast to exceed 10 trillion dollars in 2010 • In recent years CBs and SWF embarked on a „collective diversification journey” (particular attention given to Singapore, China, Japan, Korea) • Goal: understand why this happened, what are the likely consequences

3. Putting this in perspective … Global CB reserves Source: Hildebrand (2007), author’s modifications

4. Growth of Official Reserves Developing and Emerging Economies, USD bln. Sources: BIS, IMF, World Bank

5. Do we have enough? Source: flickr.com

6. Reserves Adequacy: Months of Imports Developing and Emerging Economies, Weighted Average Sources: BIS, IMF

7. Reserves Adequacy: Short-Term Debt Coverage (GG) Developing and Emerging Economies, Weighted Average Sources: BIS, IMF

8. Reserves Adequacy: Short-Term Debt Coverage USD m Sources: IMF IFS, BIS-IMF-OECD-WB

9. We have more than enough! Source: flickr.com

10. Usual costs of holding reserves • Cost of mopping up liquidity higher than return on reserves • Domestic currency appreciation may lead to huge losses amid long foreign currency positions • Old cost measures focused on CB balance sheet

11. New concept: OCHAR • Opportunity Cost of Holding Ample Reserves … • … is a forgone GDP growth amid too conservative central bank reserve management

12. OCHAR factors • The size of reserves (absolute or above GG rule) • The difference of returns between optimal strategy in the long-run and actual short-term focused strategy pursued by CBs • The country specific ability to translate additional income into projects with high social rate of return

13. OCHAR, second factor - strategy Global portfolio: US, Germany, UK (actual currency shares are weights) CB: 1-3 government bonds Pension: 40% bonds (1-3), 60% stocks, Merill Lynch indices

14. Opportunity cost: factors 1 & 2,% GDP (5yr average)

15. OCHAR – third factor – good/bad government • Higher central bank profits can be wisely invested to enhance potential output or … • … can be wasted on potential-growth reducing social handouts • This factor is country specific • We use infrastructure spending coefficient (Munnel [1992]) of 0.39

16. OCHAR, % GDP

17. Two strategies. First – keeping reserves at the „optimal” level Source: Green, Torgerson (2007), author’s modifications Examples: Slovakia, Switzerland, Mexico

18. Two strategies. Second – raising marginal revenue Source: Green, Torgerson (2007), author’s modifications Strategy adopted by majority of CBs

19. The central bank collectivediversification journey Source: flickr.com

20. XX century investing vs. XXI century investing by CBs GIC, 9.5% pa. Very conservative central bank, capital protection strategy Source: World Bank Treasury, author’s modifications

21. What are the implications?

22. Changes is assets relative prices • Implication 1: relative asset prices in XXI century will change, and often will have very little in common with historical averages in XX century (some asset prices may not be mean-reverting). Emerging markets as new safe heaven???

23. Some recent evidence of relative risk re-pricing Source: BIS quarterly, March 2007. Record low emerging market CDS spreads suggest significant reduction of credit risk in emerging markets relative to US corporate risk in the same credit category

24. EM volatility below major markets volatility • In 2007 late Feb – Mar episode local and sovereign EM debt was the most stable asset class – PIMCO (April 2007) JPMorgan (2006) Correlation of EM volatility and core markets volatility has gone up

25. Re-pricing of risk, emerging markets Source: IMF, „Global Financial Stability Review”, September 2007.

26. From Greenspan put to Bernanke kaput* • Is CB action causing massive moral hazard? • Is policy geared towards stabilization in developed world causing EM boom? Phrase borrowed from HSBC research note

27. Other implications • US will loose „exorbitant privilege” (Gourinchas, Rey (2005))* • Faster developments of financial markets in Asia, maybe leading to common currency „asian” (work on regional financial mechanism „AMF?” already started)* • Better allocation of assets globally leading to higher global growth • Possibly higher short-term volatility • CBs likely to use market risk reassessment periods to accelerate diversification process *Explained in detail in K.Rybinski „Globalizacja w trzech odsłonach”, to by Difin, May 2007 (in Polish), current discussion of these topics on author’s blog www.rybinski.eu (in English)

28. Global risk? • What if global four-sigma event shuts off many markets, and liquidity is gone. Will CBs acting as good asset managers be able to act timely as lenders of the last resort? • Shocks are becoming increasingly global (Ehrmann, Fratzscher (2006)), only heavyweights can deal with these shocks

29. Central bankers’ job is becoming increasingly challenging Source: flickr.com