Optimal level of reserves Optimal level of reserves

Washington, October 20 2006

XXIV Meeting of the Latin American Network of Central Banks

and Finance Ministries

Adrián Armas

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 resourcesResources used to constitute the pool may not 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

GDP growth: Correlation coeficient, 1990: 2006

ARG

BOL BOL

BRA BRA

CHI CHI

COL COL

ECU ECU

PAR PAR

PER PER

URU URU

VEN VEN

higher than 0,50 10 casesBetween 0,40 - 0,49 14 casesLower than 0,39 21 cases

5

However, correlation among spreads can signal some potential simultaneity in the

demand for resourcesCorrelation coeficient EMBI: 1998 - 2006

EMBI+

LATIN LATIN

ARG ARG

BRA BRA

COL COL

ECU ECU

MEX MEX

PER PER

VEN VEN

CHI

Higher than 0,50 32 cases

Betw een 0,40 and 0,49 3 cases

Lower than 0,39 10 cases

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)

-0,1

1,0

3,2 3,3

2,52,3

1,7

1,0

0,3

-1,1

-2,0

-1,0

0,0

1,0

2,0

3,0

4,0

* June (last 4 quarters)

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006*

8

Public debt1999 – 2006

(as percentage of GDP)

47,145,4 45,9 46,5 47,0

44,3

37,835,3

10,0

20,0

30,0

40,0

50,0

1999 2000 2001 2002 2003 2004 2005 2006 *

* June

9

Financial dollarization indicators

Even though dollarization indicators in Peru show a decreasing trend over the last few years, financial

dollarization is still high

* August

40

45

50

55

60

65

70

75

80

85

1997 1999 2001 2003 2005

Monetary aggregate Credit to the private sector

2006*

10

Monetary policy framework in Peru

Inflation targeting

+

Financial dollarization risks control

Dedollarization policies

Internalization of risks and policy responses to negative shocks

11

Financial dollarization risks

Financial dollarization risks Policy responses

Liquidity risk (maturity mismatch) Inflation targeting framework

Exchange rate risk Capital market development in domestic currencyHigh reserve requirement on foreign currency liabilitiesHigh level of international reservesCentral bank moderates excessive exchange rate volatility

12

Net international reserves1997- 2006(in billions of US$)

10,29,2

8,4 8,2 8,69,6

10,2

12,6

14,115,2

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

* September

*

13

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

Moody's - S&P Ratings

External vulnerability

indicator 1/ 2/

Peru (Ba3 - BB) 2,56

Argentina (B3 - B+) 0,56

Brasil (Ba3 - BB) 0,68

Chile (Baa1 - A) 1,24

Colombia (Ba2 - BB+) 0,99

Ecuador (Caa1 - CCC+) 0,22

El Salvador (Baa3 - BB+) 0,78

Mexico (Baa1 - BBB) 1,82

Paraguay (Caa1 - B-) 1,82

Venezuela (B2 - BB-) 1,65

1/ NIR / (Short-term external debt + Amortization paid on external debt)

14

International liquidity indicators should also consider financial

dollarization risks

11 months 11 months

2,6 times 2,7 times

0,9 times 1,0 times

1/ NIR and foreign exchange position as of September 30, imports as of August 31 and short term external liabilities as of June 30.

NIR / (Short term external liabilities+ Banking system foreign currency broad money)

2005 2006 1/

NIR / Imports of goods and servicesNIR / Short term external liabilities

1/ NIR as of September 30, imports as of August 31 and short term external liabilities as of June 30.

15

Foreign exchange interventionJanuary 2002 – September 2006

Brasil, 2002

Peru, presidential elections

Precautionary accumulation of reserves

16

0

2

4

6

8

10

12

14

16

18

Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06

8 000

10 000

12 000

14 000

16 000

CDBCRP / credit NIR

Risks in reserve accumulation

Percentage

CDBCRP balances relative to credit to the private sector

Billions of US$

17

0

2 000

4 000

6 000

8 000

10 000

12 000

Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06

2,0

2,5

3,0

3,5

4,0

4,5

5,0

5,5

CDBCRP balances Interest rate Reference rate

Risks in reserve accumulation

Millions of S/. Percentage

CDBCRP balances and average interest rate of CDBCRP: 2003- 2006

18

0,0

1,0

2,0

3,0

4,0

5,0

6,0

Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06

Interest rate of CDBCRP 3 month LIBOR

Risks in reserve accumulation

Percentage

Average interest rate of CDBCRP and 3 month LIBOR

19

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.