DP5483 The Social Cost of Foreign Exchange Reserves

Author(s): Dani Rodrik

Publication Date: January 2006

Keyword(s): emerging markets , financial crises

JEL(s): F4

Programme Areas: International Macroeconomics , Public Policy

Link to this Page: www.cepr.org/pubs/dps/DP5483.asp

There has been a very rapid rise since the early 1990s in foreign reserves held by developing countries. These reserves have climbed to almost 30% of developing countries' GDP and 8 months of imports. Assuming reasonable spreads between the yield on reserve assets and the cost of foreign borrowing, the income loss to these countries amounts to close to 1% of GDP. Conditional on existing levels of short-term foreign borrowing, this does not represent too steep a price as an insurance premium against financial crises. But why developing countries have not tried harder to reduce short-term foreign liabilities in order to achieve the same level of liquidity (thereby paying a smaller cost in terms of reserve accumulation) remains an important puzzle.