Research On Foreign Exchange Reserve Issues Of Emerging Market Countries

Foreign exchange reserves are important financial assets of a country to regulate balance of payments,exchange rate policies,and economic operations,and are closely related to many issues in the international economic area.Since the beginning of the 21 st century,emerging market countries,including China,have begun to accumulate large amounts of foreign exchange reserves for mercantilist motives or preventive motives.Previous studies have shown that sufficient foreign exchange reserves can help to withstand the financial crisis,balance the balance of payments,stabilize the exchange rate,etc.But with the development of economic globalization and financial integration,more and more researches support that excessive foreign exchange reserves increased the cost of holding and the hidden foreign exchange risk,and affected the domestic macroeconomic operation,etc.Therefore,exploring the link between foreign exchange reserves and macroeconomic of emerging market countries has important practical and policy implications.Research on the modest size,currency structure,and investment portfolios of foreign exchange reserves has become increasingly abundant,but research focusing on the macroeconomic effects and financial stability of foreign exchange reserves remains to be further explored.The foreign exchange reserves' related issues are very complex,and this article cannot cover all aspects.Exchange rate and money supply occupy the main positions in the transmission mechanism of foreign exchange reserve and macroeconomic,and capital flow and foreign trade are the main sources of foreign exchange reserve,therefore,this paper chooses the monetary policy independence,the actual effective exchange rate,foreign trade,capital flow and other macro variables as the main research objects.At the same time,in order to better integrate the special phenomena of emerging market countries,this article selects four important perspectives to study the foreign exchange reserves of emerging market countries,to enrich existing research and provide reference for emerging market countries' foreign exchange reserve management.The main contents are as follows:(1)This paper studies the financial stability function of foreign exchange reserves from the perspective of the relationship between foreign exchange reserves and financial fragility in emerging market countries.Foreign exchange reserves have an impact on the domestic financial sector through specific transmission mechanisms.This paper sorts out the transmission mechanism from the perspectives of money supply,interest rates and asset prices.Empirical study is done based on the data of “BRIC countries”,including China,Brazil,Russia,India and South Africa.This paper uses Johansen co-integration test and Bayesian vector autoregressive modeling method to empirically study the relationship between changes of foreign exchange reserves and financial fragility.This paper innovatively constructs the financial vulnerability index to measure the stability of a country's financial sector.The greater the financial vulnerability index,the stronger the ability of the financial sector to respond to the crisis.Studies have shown that,in the long-term or short-term,the increase in foreign exchange reserves will increase the financial fragility index and help the country cope with short-term economic fluctuations.Therefore,increasing foreign exchange reserves will help the domestic financial sector to stabilize and resist the economic crisis.(2)This paper studies Dilemma Phenomenon of emerging market countries from the perspective of the relationship between foreign exchange reserves and monetary policy independence.After the Asian financial crisis,a large number of emerging market countries abandoned the fixed exchange rate system and adopted floating exchange rate system in order to achieve their monetary policies independence.However,in fact,emerging market countries which adopting floating exchange rate system failed to achieve capital flow freely and the monetary policy independence at the same time.This phenomenon is called “Dilemma Phenomenon”.This paper innovatively introduces the accumulation of foreign exchange reserves into the Mundell-Fleming model,and discusses the influence of foreign exchange reserves accumulation on expansionary monetary policy which can increase output,under three conditions including capital flow freely,capital flow incomplete freely and capital non-flow completely.Empirical study is done based on 25 emerging market countries such as China,Brazil,Poland,and South Africa.The study finds that after the crisis,the emerging market countries that implemented floating exchange rate system did not achieve monetary policy independence.Rapid accumulation of foreign exchange reserves weakened the positive effect of the increase in money supply on output.As a result of holding foreign exchange reserves,the monetary policy independence in emerging market countries has been challenged,independently of the type of exchange rate system adopted,which proves the existence of dilemma phenomenon.(3)This paper studies the relationship between foreign exchange reserves,foreign trade and the real effective exchange rate of emerging market countries.The research on real effective exchange rate has mostly focused on the direction of capital flows,ignoring the combined effects of foreign trade and foreign exchange reserves.This paper innovatively explains the relationship between real effective exchange rate,foreign exchange reserves,and foreign trade from a micro perspective.By solving the problem of maximizing consumer utility under the constraints of the budget,regarding foreign trade and foreign exchange reserve as endogenous variables,this paper derives long-term and short-term effects of foreign exchange reserves and foreign trade on real effective exchange rate.Based on the annual data of emerging market countries from 1998 to 2018 and China's quarterly data from 1998 to 2017,the empirical results are done,and the conclusion is consistent with the model derivation.The study found that foreign exchange reserves have a significant negative impact on the current effective exchange rate,and a positive impact on the next effective exchange rate is not significant.In the long run,the overall impact is negative;there is a negative relationship between export trade dependence and the real effective exchange rate,the relationship between import trade dependence and the real effective exchange rate is not significant,but there is a stable equilibrium relationship between the foreign trade and the real effective exchange rate;in the short term,increasing the foreign exchange reserve and promoting exports will cause the real effective exchange rate to fall,and increasing imports will cause the real effective exchange rate rose,which are in line with long-term results.For emerging market countries,appropriately reducing the size of foreign exchange reserves and reducing export dependence will help to increase the effective exchange rate of the country and enhance the competitiveness of its currency.(4)This paper explores the joint utility of capital controls and foreign exchange reserves in the management of cross-border capital flows in emerging market countries for the first time.Capital flow management is an important issue for emerging market countries.This paper first analyzes the channels in which foreign exchange reserves affect capital flows,and then constructs a three-stage loan model to link the domestic lending market,the international lending market and the central bank,and derives between foreign exchange reserves,capital controls and capital inflows from the perspectives of maximizing the interests of representative enterprises and maximizing the central bank effect.Based on the annual data from 1994 to 2017 of 22 emerging market countries such as China,Brazil,Chile,India,etc.,empirical research uses panel system GMM method and panel binary selection model.Finally,the robustness test is performed by replacing the foreign exchange reserves' proxy variable and redoing empirical study based on Chinese data.The results show that for emerging market countries,increasing foreign exchange reserves will help attract short-term capital inflows and curb capital outflows.Capital inflow controls have no significant impact on capital inflows,but strengthening capital outflow controls can effectively reduce capital outflows.Strengthening capital controls will help reduce the probability of “sudden stop”;the stricter capital controls,the more foreign exchange reserves need to prevent “sudden stop”.The two policies complement each other,effectively controlling the net capital flow of emerging market countries.China,as the largest emerging market country,has its particularities.Capital controls have a small impact on capital flows.There is still a complementary relationship between foreign exchange reserves and capital control policies.The innovation of this paper is mainly reflected in three aspects:(1)verify the financial stability function of foreign exchange reserves by studying the relationship between foreign exchange reserves and financial vulnerability;(2)explain macro issues from a micro perspective,and introduce foreign exchange reserves,foreign trade,real effective exchange rates,capital controls,and capital flows into the microeconomic model to derive the interaction between these variables;(3)focus on unique issues of emerging market countries,such as the Dilemma Phenomenon and Sudden Stop,provide new research ideas from the perspective of foreign exchange reserves.Based on the above conclusions,this paper innovatively proposes the core point: for emerging market countries,although the accumulation of foreign exchange reserves reduces the monetary policy independence and the real effective exchange rate,it improves the financial stability,smooths the fluctuation of capital flows,and effectively exerts the financial stability function to a certain extent.Finally,this paper proposes policy recommendations for the management of foreign exchange reserves in China and emerging market countries respectively.For example,appropriate reduction of foreign exchange reserves can enhance monetary policy independence,but it is necessary to control the rate of reduction not to be too fast,so as to avoid a significant increase in financial fragility.A country can reduce the cost of holding foreign exchange reserves by steadily promoting the convertibility of capital account,and using various financial instruments.Encouraging people to hold foreign exchange reserves is a good idea for government to reduce cost.To deal with capital flow shocks,foreign exchange reserve management and capital control policies have their advantages and disadvantages respectively.How much foreign exchange reserves a country should hold and how to regulate capital control policy,the government should consider based on the actual situation of economic.There are still some shortcomings in this paper,and the research on the foreign exchange reserves issues is not complete.In the future,China and other emerging market countries will still face severe foreign exchange reserve management problems,and foreign exchange reserves change will also have a profound impact on the domestic financial system.It is of great significance to further study this topic.