6. Balance of Payments
6.2 Foreign Reserves
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account, i.e. being more positive when the financial account is more negative and vice versa.
6.2 Foreign Reserves
As seen, in absolute terms Taiwan’s reserve account shows a tendency to increase (to become more negative). A change in reserves is a strong argument for exchange rate intervention by the central bank, however it is important to link it to GDP. For instance, one billion US dollar worth of foreign reserve accumulation might mean a large impact on the Danish Krona, but nearly no impact on the USD exchange rate.
Doing so reveals a phase of strong reserve accumulation (intervention) between 1984 and 1987, then a phase of only little intervention, and finally another phase of
increased accumulation after 1998. Due to the low reserve account for 2011, 2012 and 2013, the account shows a negative trend starting at 1998 (which marks a change in monetary police, as shown later), so does it starting 1984. This is robust, as excluding 2013 and 2012 still reveals a stable trend, i.e. a non-increasing one. Therefore, though over the same period the current account surplus relative to GDP increased from 1.12% to 10.81% and the real nominal exchange rate spread increased significantly, the need for central bank intervention to maintain this trend/spread did not parallel increase. This is surprising, as over time a weak exchange rate should pull in more arbitrageurs, especially once the price level difference appears stable and even
defended. Also, relatively long periods (years) without an increase in foreign reserves imply that at least temporarily the exchange rate is close to its natural equilibrium.
Therefore, while the central bank keeps on accumulating foreign reserves (with the exception of 2007 where it lowered its stock), it does not do so in a magnitude that by itself would explain the creation or persistence of the real/nominal exchange rate spread.
Many arguments can be made pro and con an accumulation of foreign
reserves. One perspective is, that accumulating reserves and then sterilising by issuing central bank bonds replaces private foreign investment with public foreign
investment. Thereby, private households get rid of the exchange rate risk, netting a
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lower risk for a constant return. Noyer (2007) argues however, that as taxpayers, the holders of central bank bonds are still collectively exposed to the exchange rate risk, as they ultimately have to balance out the difference in interest payments the central bank faces. As the data shows, Taiwanese portfolio investment on average shows a negative balance, signifying outbound portfolio investment does not need to be
channeled through the central bank in Taiwan’s case and it might even have a negative redistributing effect as tax payers are collectively responsible, externalities are low and creditors benefit from the decrease in investment risk.
Either way, the question remains what the central bank is doing with the increasing reserve stock. According to the bank’s website, the foreign reserve serves not only the purpose of ‘maintaining liquidity, security, and profitability’, but also is utilised to promote ‘economic development and industrial upgrading.’ This is
achieved by appropriating the funds that are required by domestic enterprises for the import of investment goods, by establishing a “computerised network system with brokerage firms in major international financial centers” handling the more than USD 22 billion worth of foreign reserves set aside for the currency call-loan market, and by depositing reserves in oversea branches of domestic banks in order to ‘promote
Figure 6.2 Foreign Reserves
1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 Reserves/GDP Reserves Account BOP
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international financial activities and to support the Taiwanese firms located there.’ The majority of foreign reserves is held in US-Dollar, with the second and third largest part held in Euro and Japanese Yen respectively. The composition is comparable to those held by other major central banks, according to the CBC.
According to the CIA World Factbook, by world comparison, Taiwan Ranks 6th in total amount of foreign reserves and 8th on a per capita basis. This means 24 25 Taiwan holds 3.2% of all foreign reserve assets held by central banks worldwide. The same source ranks Taiwan 43rd on a nominal GDP per capita basis (a PPP comparison does not make sense as foreign reserves are not set into relation to the price level of the country holding them) and we have to bear in mind that every country excelling Taiwan’s per capita foreign reserve quote is either an extremely high income country (and with the exception of Switzerland a city state) or a rentier state, i.e. oil exporting.
The fast pace of this accumulation becomes explicit, when comparing it with Taiwan’s overall GDP. While it stood at close to 35% in 1999 and fell to around 32% in 2000, it passed 50% in 2002 and skyrocketed to 89% in 2009. Since then it had fallen,
however not significantly. The trend suggests a ratio of 100% at the end of 2015 or 2016.
The question when foreign reserves become excessive is not an easy one to answer. Noyer assesses the appropriate amount of reserves relative to the objectives for holding them, which are
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“‘support and maintain confidence’ in monetary and exchange rate policy, including the capacity to conduct foreign exchange interventions;-
‘limit external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed, and in doing so,-
provide a level of confidence to markets that a country can meet its external obligations.’”One approach is the Guidotti–Greenspan rule, named after the former chairman of the Federal Reserve Board Alan Greenspan and Argentine’s former
behind China, Japan, Saudi Arabia, Switzerland and Russia
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behind Switzerland, Singapore, Hong Kong, Macau, Saudi Arabia, Libya and Qatar
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deputy minister of finance, Pablo Guidotti. It suggests a country’s foreign exchange reserve should equal it’s short-term debt (Greenspan (1999)). The idea is, that a country becomes completely independent from foreign investment for at least one year, preventing crises like the Asian Financial Crises 1997/98 in case creditors refrain from rolling loans over.
Table 6.2 reveals that the ratio for foreign reserves over short term debt for Taiwan is much larger than what the Guidotti-Greenspan rule would suggest. In 2007 the ratio was at 3.25, it grew until 2009 (5.11) and from then on steadily declined.
This though reflects not a significant decrease in foreign reserves, but a huge increase in short-term debt, which is, according to the central bank, solely attributable to the private sector. Interestingly, for the same period we can find a net outflow of investment, which makes it likely that the increase was bidirectional and the associated risk is less than if the rising short-term debt were correlated with a net inflow of capital.
Combining those findings, it becomes obvious that Taiwan’s reserves cannot continue to grow without bound and that this bound is approaching very fast. At the same time, it is unclear how a change in monetary policy would affect the real/
nominal exchange rate, as the current monetary policy has support the spread, but it didn’t solely create it. Also, it is possible that the funds that are now invested abroad by the central bank would then be invested abroad by the private or institutional
Table 6.2 Foreign Reserves and Short Term Debt
Year Foreign Reserves Short term debt Ratio (suggested Ratio: 1)
2007 270,311 83,283 3.25
2008 291,707 78,773 3.70
2009 348,198 68,179 5.11
2010 382,005 83,669 4.57
2011 385,547 107,782 3.58
2012 403,169 116,501 3.46
2013 416,811 155,635 2.68
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sector, shifting the cashflows within the balance of payments, but not affecting the exchange rate.