Strategic Management of Foreign Reserves

At the start of the Asian financial crisis, panic triggered a massive sellout of the peso in favor of the dollar. The massive sellout of the peso which also led to sudden excess demand for dollars increased the exchange rate from P26/$ to P32/$ in three months. Unfortunately, sudden excess demand for dollars happened a few more times. If only there were enough dollar reserves. Some dollar reserves could have been sold to offset the demand. The offsetting would have kept the exchange rate stable.

The reaction has been for the Bangko Sentral ng Pilipinas(BSP) among other central banks in East Asia to consciously and deliberately accumulate foreign currency reserves. From 2000 to 2008, the BSP reserves measured in terms of the Gross International Reserves (GIR) roughly tripled from $15 billion to $44 billion.

It is concomitant that the consensus strategic management of the $44 billion reserve was what Park and Estrada (2010, Philippine Review of Economics) referred to as “passive liquidity management.” “Passive” in the sense that the reserve was deposited in safe assets. That is “liquidity” in the sense that the dollar assets can be abruptly withdrawn and be supplied should there be sudden surges in demand. This way, the GIR can serve as a self-insurance to defend the peso against currency attacks. Should there be massive sellout (hence sudden excess demand), the BSP had $44 billion reserves to supply, to offset the demand.

In 2010, the consensus strategic management was challenged when the GIR surged by more than 40 percent to over $62 billion. A very simplistic yet exaggerated example might help to explain. If Maria the typical domestic helper has a reserve of P5 thousand, it is wise for her to put that in a safe place. Should there be an emergency, it can easily be taken. Hence, “passive liquidity management” is her best strategy. But if Maria has a reserve of P500 thousand, it is not wise to put that all in the same “safe” place. The wiser thing to do is put something like P5 thousand in the same “safe” place and put the rest in a higher-earning but riskier investment. The better strategy for Maria is –using the words of Park and Estrada – “active profit-seeking investment.” Of course Maria’s case is an exaggeration which eases the choice of strategy. The case of the Philippines in 2010 was more complicated. Still, the “active profit-seeking investment” strategy began to challenge the hardcore strategy of “passive liquidity management.”

In 2012, another strategic management emerged when the GIR surged to $85 billion; that is $20 billion bigger than the foreign debt of $62 billion. Allow me to call the strategy as “external debt management.” The strategy was proposed by the BSP to the Department of Finance (DoF) (Navarro and Yap, 2013, Development and Research News) in 2012. The simplified version goes this way: the government borrows in pesos, use those pesos borrowed to buy dollar reserves, and use those dollars bought to pay dollar debts. This would slow reserve accumulation, but it could be argued that the reserves are reaching an excessive level, anyway. This would also increase the peso debt, but it would also decrease the dollar debt. Whether the BSP has adopted some flavor of this strategy is not clear.

Still there is another strategic management I call “active inclusion” to consider. “Active inclusion” has not been done in this country, but mentioning some examples help explain it. In the 1970s, with so much reserves and with poor infrastructure in telecommunications, the Abu Dhabi Investment Authority (ADIA) guaranteed loans to Emirates Telecommunications to expand capacity to the likes of Chase Manhattan Bank, Deutsche Bank, etc. Imagine using a small amount (not all) of $85 billion as financial guarantee to finance the Philippine highway system. Singapore, with its wealth of foreign currency allocates some management activities to international investment banks that agree to locate significant operations in Singapore (Balding, 2012, SWF). With the BSP’s $85 billion, imagine contracting some of the reserves’ management (not all) to a foreign bank provided that that foreign bank produces at least 10 thousand jobs in BPO (business process outsourcing) and call center operations in the Philippines.

In 2008, the China Investment Corporation (CIC) sold bonds worth 1.6 trillion CNY that otherwise was financing the real estate bubble, credit card consumption and causing inflation. The CIC then used the 1.6 trillion to purchase $200 billion from China’s foreign reserves. To make the story short, the CIC then used the $200 billion to finance China’s labor-intensive industrialization and infrastructure. That is rechanneling spending from consumption to infrastructure, from real estate to railway and highway systems, and from leisure to productivity-enhancing projects. That is “active” government involvement towards “inclusion.”

Luis F. Dumlao, Ph.D., is Chair, Department of Economics, School of Social Sciences, Ateneo de Manila University.

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