High Foreign Exchange Reserves – Blessing Or Burden

The general perception among the economic experts and policy makers in emerging countries regarding foreign exchange reserves is such that the more, the better. They consider high foreign exchange reserves as a blessing. However, this perception is fast changing because of the flexible exchange rate regime being followed in most parts of the world. Also, the ability to borrow the domestic currency has also eased pressure on the nations to accumulate reserves and thus descending the importance of having a high forex exchange reserves. Although the developing economies are still trying hard to maintain their adequate forex reserves levels. It’s not been long since questions have been raised regarding the need for having high foreign exchange reserves or if these are blessing or burden for an emerging country.

There are various factors which decide whether high foreign exchange reserves are a blessing or a disguise. Different countries have different interests and motivations behind accumulating high forex exchange reserves. There are various costs which are involved and nations have to bear while maintaining high reserves in foreign exchange.

The most obvious reason behind emerging markets holding up high foreign exchange reserves is to play safe during any kind of currency crises. The central banks can make use of forex reserves at any point of time to manipulate the market even when there are not nay crises in the market. The basic purpose behind bank’s intervention is either to reduce volatility in the market or to maintain a target exchange rate.

There are many countries which maintain high reserves in foreign exchange to buy foreign goods or make payments using foreign currencies for services to international organizations. The governments also spend forex reserves on investment projects, however obeying a condition that these reserves cannot be converted back into local currency if authorities wish to avoid an impact on the exchange rate.

Having high foreign exchange reserves may help countries rendering a false sense of security and thus act as a major roadblock in the path of some necessary reforms which are required to have a strong economy. It might be true that while high reserves in foreign exchange helps in providing some sort of protection against external crises, otherwise unsustainable policies cause undesirable distortions even when they do not end in crisis. However, it is also important to realize that there should be a proper mechanism to describe the adequate level of forex reserves and that should be followed by all.