International Reserves Accumulation
in Emerging Countries with Flexible Exchange Rates
Patricia Rodríguez and Omar Ruiz
THEORETICAL CONSIDERATIONS ON
OPTIMAL INTERNATIONAL RESERVE LEVELS

Various vulnerability or early warning indicators exist to determine the IR level. The most well-known are: the IR/import ratio, which was the rule traditionally followed by central banks for several years until it fell into disuse after Bretton Woods system ended, and was proposed by Robert Triffin (1947); according to this rule, the central bank must maintain its reserve levels at the equivalent of three or four months of imports; other examples include the relationship of IR between a fraction of the M2 monetary aggregate, as well as the IR/short-term external debt. Vulnerability indicators are generally classified as follows:

Of these composite indicators, we should draw attention to the ratio of reserves to short-term debt, known as the Guidotti-Greenspan rule, which states that “countries should hold liquid reserves equal to their foreign liabilities coming due within a year” (Rodrik, 2006: 5). Currently this is the main early-warning indicator, used to evaluate possession of monetary assets. Since it was announced by Pablo Guidotti (Argentinas former Minister of Finance) and when it was picked up again by the Alan Greenspan, former Chairman of the Federal Reserve of the United States, it rapidly became popular. “the rule of a level of reserves equal to short-term debt should be viewed as a starting point for analyzing reserve adequacy for a country with significant but uncertain access to capital markets” (Mulder & Metzgen, 2001: 67).

Guzmán & Padilla (2003: 176) show the importance of this ratio and its superiority over other indicators of vulnerability; such is its importance that the International Monetary Fund (IMF) has incorporated this coefficient as one of its indicators; but the limits to this quotient are also explained, for example: the divergent methodologies used by each country limits comparisons; observations of this variable are published several months after the date in question and in various countries the external debt is only published on an annual basis. “This complicates the analysis and research, especially given the important financial innovations of recent years, the Guidotti-Greenspan rule should be a variable used for a joint analysis” (Ruiz, 2011: 29). The equation for the optimal level is:

IR* = IR = 95% of STD

where:

IR* = Optimal international reserves

IR = Total amount of reserves

STD = Short-term external debt

There are also various models to estimate the optimal demand for international reserves (IR*), most of which are more complex than the aforementioned early-warning indicators. Some of them are described by Ruiz (2011) and Palacios (2007).

The Wijnholds-Kapteyn methodology (W-K). This methodology (see Wijnholds & Kapteyn, 2001) is an extension of the Guidotti-Greenspan rule; it is a model that proposes incorporating capital flight of residents in a given country in order to estimate the optimal level of foreign currency assets; its authors suggest setting an optimal reserve level that combines internal capital flights with external flights. Some authors call this the Wijnholds-Kapteyn-Triffin model (for example Palacios, 2007: 120) since at the time of estimating the IR* they incorporate the 3 or 4 months of imports as proposed by Triffin, with the aim of factoring in the continuity of international payments.