‘Fight’ against dollar lowered foreign reserves of countries around the world, says IMF

Foreign currency reserves around the world shrank by 10% in the first nine months of last year, as countries like Japan struggled to defend their currencies against the rapidly strengthening dollar.

The global total fell to US$11.6 trillion at the end of September, falling below US$12 trillion for the first time since March 2020, according to the International Monetary Fund (IMF).

“This likely reflects countries selling reserves, mainly dollars, to support their own currencies,” said Yoshimasa Maruyama of SMBC Nikko Securities.

Japan’s reserves fell 13% on the year to US$1.23 trillion at the end of 2022, the first drop in six years and the steepest in comparable data since 2001, according to government statistics released on Wednesday.

As the yen weakened sharply in September and October, at one point beyond 151 yen to the dollar, Tokyo sold dollar-denominated assets for the yen to try to stem its slide.

These withdrawals deplete an important source of funds not only for such interventions, but also for the payment of debts in foreign currency, and can leave countries more vulnerable to economic turmoil.

While currency markets have stabilized for the time being, the risk of another dollar spike remains, which could send countries into a new crisis.

Emerging economies such as Sri Lanka performed especially poorly. Its bookings have fallen by more than 40% between late 2021 and November, according to IMF data, as a slump in tourism has contributed to a dire foreign currency shortage.

Asian countries with few natural resources also saw considerable declines, with South Korea’s reserves falling 10% amid efforts to prop up the won.

The trend has started to change in some countries as the dollar’s appreciation slowed in the final months of 2022.

Turkey’s foreign currency reserves, for example, fell sharply when President Recep Tayyip Erdogan’s insistence on keeping monetary policy loose sent the Turkish lira down. After pressure on the currency eased, however, the country actively worked to replenish these assets and ended up with a higher total than at the end of 2021. South Africa also increased its reserves.

But reserves in much of the world remain at worryingly low levels based on the IMF’s reserve adequacy metric (ARA) assessment, which looks at whether countries have enough foreign currency on hand to cover potential capital flight.

According to Japan’s Dai-ichi Life Research Institute, Turkey now has just 53% of the reserves it needs under this measure – well below the IMF recommendation of 100% to 150%.

China, which has the world’s largest foreign exchange reserves, is at around 60% of its ARA metric after a 4% drop in its holdings at the end of 2021 and November, suggesting it remains vulnerable to capital flight.

There is speculation that the US central bank (Fed) could start cutting interest rates again as early as this year, which would contain upward pressure on the dollar. But the dollar could gain strength again if inflation lasts longer than anticipated.

“The worst is over compared to when the dollar’s strength peaked in the third quarter of 2022, but if it appreciates again, countries will have limited resources to support their currencies,” said Toru Nishihama of Dai-ichi Life Research.

With information from Valor Eonômico

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