T HE O PTIMAL FOREIGN RESERVES : C ASE OF
C ROATIA
µ
Ana Maria Ceh,
Ivo Krznar
HNB
June 25
(HNB)
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T HE MAIN QUESTIONS
What is the optimal level of foreign reserves the CNB should hold?
Are CNB foreign reserves su¢ cient to mitigate negative e¤ects of
potential sudden stop and banking crisis?
Is there a rationale for recent hoarding of foreign reserves in Croatia?
Since 1998 CNB foreign reserves have increased by four times
Do we have too much of a good thing?
How do optimal reserves compare to "standard" indicators of reserves
adequacy?
(HNB)
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M OTIVATION
Optimal reserves take into account bene…ts and costs from holding
reserves
Bene…ts: precautionary motives or self-insurance against double drain
risk in dollarized economies (future sudden stops accompanied with
banking crises)
foreign reserves act as an insurance against negative e¤ects of a sudden
stop and a key tool for managing domestic …nancial sector stability
300
Public sector short-term debt
Private sector short-term debt
Euro deposits
250
%
200
150
100
50
0
1998
(HNB)
1999
2000
2001
2002
2003
2004
2005
O PTIMAL RESERVES : C ASE OF C ROATIA
2006
2007
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M OTIVATION
Costs: opportunity costs from holding reserves (investing into high
yield assets, repaying external debt)
Inadequate "standard" indicators of reserves adequacy
(HNB)
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T HE MODEL
A simple dynamic stochastic general equilibrium model with 3 sectors
(households/…rms, private banks, government/central bank)
The only source of uncertainty comes from probability of sudden stop
that occurs in tandem with banking crisis
During crisis
short-term foreign loans of every sector are not rolled over,
GDP falls by some fraction,
kuna/euro exchange rate depreciates,
a part of kuna deposits (both household and corporate) is exchanged
for euro deposits,
a bank run occurs - a fraction of overall deposits of non-…nancial sector
is withdrawn from banks,
banks and households withdraw their foreign liquid assets from abroad
to use them as a bu¤er against a sudden stop
(HNB)
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G OVERNMENT /C ENTRAL BANK AS A S OCIAL
P LANNER
Maximizing the welfare of the economy by choosing optimal level of
foreign reserves
Precautionary motives of demand for foreign reserves
Balancing between
Bene…ts of holding reserves
substituting lost access to market for short term foreign debt
easing credit crunch by providing foreign liquidity during bank run
AND
Costs of holding reserves
reserves earn low return
(HNB)
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O PTIMAL RESERVES
Optimal reserves will increase with
short-term external debt
possible foreign deposits withdrawal
output loss, probability of sudden stop, and exchange rate depreciation
Optimal reserves will decrease with
their costs
high alternative bu¤er (foreign liquid assets of private sector)
Relation with Greenspan-Guidotti rule?
(HNB)
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O PTIMAL AND A CTUAL RESERVES
The model was calibrated on 1998/1999 sudden stop with banking
crisis
10,000
Actual Reserves
Optimal Reserves (LOR)
Optimal Reserves
8,000
mil. EUR
6,000
4,000
2,000
0
-2,000
1998
(HNB)
1999
2000
2001
2002
2003
2004
O PTIMAL RESERVES : C ASE OF C ROATIA
2005
2006
2007
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S TRUCTURE OF O PTIMAL R ESERVES
Decomposition of optimal reserves where mother banks act as a lender
of last resort
15,000
12,000
mil. EUR
9,000
6,000
3,000
0
-3,000
-6,000
1998
1999
2000
Output loss
Foreign assets
Optimal reserves
(HNB)
2001
2002
2003
2004
2005
2006
2007
External debt
Possible deposit withdrawal
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C OMPARISON OF S TANDARD I NDICATORS AND
O PTIMAL RESERVES
10,000
Actual Reserves
Optimal Reserves (LOR)
Greenspan-Guidotti Rule
3-Month Imports Rule
8,000
mil. EUR
6,000
4,000
2,000
0
-2,000
1998
(HNB)
1999
2000
2001
2002
2003
2004
O PTIMAL RESERVES : C ASE OF C ROATIA
2005
2006
2007
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12,000
12,000
10,000
10,000
8,000
8,000
m il. EU R
m il. EU R
C OMPARISON OF S TANDARD I NDICATORS AND
O PTIMAL RESERVES
6,000
6,000
4,000
4,000
Optimal Reseves (LOR)
Actual Reserves
Greenspan-Guidotti Rule
3-Month Imports Rule
2,000
0
0.0
2.5
5.0
7.5 10.0 12.5 15.0 17.5 20.0 22.5 25.0 27.5 30.0
Optimal Reseves (LOR)
Actual Reserves
Greenspan-Guidotti Rule
3-Month Imports Rule
2,000
0
0
(HNB)
10
20
30
40
50
60
70
Deposit withdrawal (%)
Output loss (%)
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C ONCLUSION
Precautionary demand for foreign reserves might explain recent
increase in CNB reserves
The di¤erence between actual and optimal reserves depends crucially
on the expected reaction of the mother banks during the crisis
The CNB is holding enough foreign reserves to …ght the possible crisis
of the 1998/1999 magnitude regardless of the mother banks’reaction
Using the two standard indicators of foreign reserves adequacy might
be misleading in assessing foreign reserves optimality
(HNB)
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