LatinFinance - May/June 2013 - 14

Institutional wealth – central banks

significant implications for asset valuation,
financial stability and growth.
That shift, if it happens meaningfully,
could also represent one of the most
profound opportunities yet for the capital
markets of Latin America and other
emerging regions – in particular for the
development of local bond markets, which
depend critically on central bank foreign
exchange reserve allocations.

towards a multiple reserve currency
system– incorporating leading emerging
market currencies including those of
China, Brazil, and Mexico, among others.
Chile’s central bank and the Reserve Bank
of Australia, for example, are among a
handful of China’s trading partners to
have already diversified a portion of their
reserves into renminbi.
Mandeng advocates establishing a

important progress over the past decade –
are still small and illiquid by international
standards.
The potential for such development
is not lost on Yi. Emerging markets as an
asset class are not large or deep enough
for meaningful investment by official
investors. But, he says, strides already
taken in developing Latin America’s bond
markets are “very positive”.
“I think [the] emerging markets asset
class in the future will deepen its scale and
volume and liquidity will be better. It has
tremendous potential though right now it’s
not very large.”

©REUTERS

How much is too much?

Bernanke: weighing the options

Capital markets promise

“The big capital markets innovation in
the waiting, that would be the greatest
source of capital markets reform and
change, is central bank reserve allocation
to the emerging markets,” says Ousmène
Mandeng, a former IMF official who
was, until recently, head of public sector
advisory at UBS.
Central banks could help by providing
“anchor money to allow more liquidity
and help the development of local capital
markets,” he says. “It’s a sensible argument
to make: a lot of currencies are so
attractive and liquid because central banks
are investing in them. That’s certainly true
of the main markets and that logic could
be applied to the emerging markets as
well.”
This would require central banks
moving beyond the status quo in the
international monetary system and

14 LatinFinance

May/June 2013

framework, similar to central banks’
existing gold sale agreements, by which
monetary authorities constrain allocations
to new reserve currencies. The limit could
be 15 percentage points of total foreign
exchange holdings over the next five years,
for example.
“This would help mitigate undue
volatility of the main reservable and
new reservable asset markets, help
guide market expectation, support
desired orderly reserves diversification
and provide critical support for the
development of local bond markets,” he
says. “Central banks would be guided,
similar to the central bank gold sales
agreements, by making purchases of new
currencies not in excess of an agreed limit
and during an agreed time interval.”
Such a mechanism could help develop
long-duration, local currency fixed income
markets in Latin America, which – despite

Today, there’s a growing belief among
central bankers themselves that reserve
levels have surpassed useful limits and
that the cost of maintaining them is now
too great. This raises the possibility of a
greater allocation of reserves as investable
assets.
Summers’ argument hinged on the
notion of excess reserves, which he put
at $1.5 trillion in 2006. This raises the
question: what is the appropriate level of
foreign exchange reserves for a nation to
hold? One theory, the Greenspan-Guidotti
rule for the adequacy of reserves, says
they should equal external debt maturing
within 12 months; that is, enough to cover
a sudden reversal in short-term capital.
For China, whose reserves stockpile is
$3.44 trillion, the answer is clear. Says Yi:
“We already have large enough reserves.”
Safety, liquidity and return, he says,
are the three guiding principles of reserve
managers – in that order. Reserves should
first be about self-insurance against
shocks. “The most important function of
foreign exchange reserves is increasing
confidence of the market,” says Yi. “If you
pursue safety and liquidity and a little
bit of return, the US Treasury market is a
major market.”
But, he adds: “For the reserves it is
not the case of the larger the better. At
the margin the benefit of continuing to
increase reserves is diminishing. So that
I think right now we have large enough
reserves already.”
China’s central bank buys dollars to
prevent its currency from appreciating
sharply, to keep its exports competitive.
LatinFinance - May/June 2013

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