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The past 15 years have been kumarmi by unprecedented accumulation of foreign exchange reserves by various central banks. Wikipedia defines foreign exchange forex reserves as: This accumulation came to a brief halt during the height of the financial crisis in but recovered sharply thereafter. But companies and governments in many of the EM economies have substantial foreign currency debt helped forex easily available and cheap dollar credit without adequate backing of forex reserves.
Apart from China, EMs such as Kumarmi and Saudi Arabia have called on their rainy-day stashes. A large European bank estimates kumarmi EM and oil producing countries, which hold about two-thirds of forex reserves, have started drawing upon forex reserves in to defend their currencies and this year could well end up with forex forex reserves down year-over-year, for the first time in a decade.
The trend is likely to continue as oil prices stay low and growth in EMs remains weak, reducing the dollar inflows that central banks used to build reserves and conduct monetary policy. In simple terms, reserve accumulation adds money supply to the financial system—each dollar purchase creates a corresponding amount of new local currency and helps stimulate the economy through investments in physical or financial assets.
Most central banks deploy forex inflow to buy US treasury bonds and other productive assets through their sovereign wealth funds arms.
When there is kumarmi drawdown on reserves, these assets investments in productive assets need to be liquidated to pay back the dollar. This creates a dictum on asset prices globally, which comes under pressure on desperate selling.
The drawdown on forex reserves is an additional source of uncertainty kumarmi a world already plagued by volatility. The weak commodity cycle has forced commodity exporters dipping into their reserves to make up for lower incremental dollars from export of commodity or energy, forex this will be the strongest trigger kumarmi the next leg of the dollar rally.
A side effect of a firming dollar is the forex effect it has on commodity prices, thereby leading to imported deflation in the Forex. This is as high as it is in India, which will, in turn, provide a further boost to the dollar rally. In short, conditions are ripe for a sharp forex rally and the resulting interplay of bond yields and CPI will further push up the dollar. Not to forget that the US is the only economy looking to raise interest rates in a developed world obsessed with lowering and negative interest rates.
This will only increase the allure of the dollar. In a dwindling forex reserve scenario, EM economies could find it tougher to boost their money supply and shore up faltering economic growth.
Kumarmi central banks have other ways of forex cash kumarmi the banking system, such moves without the forex of increased foreign reserves could end up weakening their currencies further—an outcome they may want to avoid.
The swing in global forex reserves is one key measure of the global liquidity tap being turned on and off. Forex a regime of loose money suddenly ends, EM asset prices are usually one of the first casualties. Regulatory curbs on foreign ownership have ensured that our bond market has been rather resilient during the recent turmoil kumarmi to the volatility seen in most EM bond markets that have higher foreign ownership.
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Naresh Kumar hits rewind. One may ask, why this development is important? Views expressed are personal. Kumarmi Jain is the chief investment officer at Tata Asset Management Co.
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