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The IUP Journal of Applied Economics
The Impact of Currency Appreciation on Role of Monetary Authorities: Evidence from Leading Reserve Holding Countries
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This paper attempts to examine whether there is any fear of currency appreciation among countries which have accumulated foreign exchange reserves beyond what is conventionally required. In this regard, the paper estimates an augmented version of buffer stock model of reserve demand and includes undue appreciation and depreciation of domestic currency as separate explanatory variables. The empirical evidence obtained from a sample of 10 highest reserve holding countries suggests: (i) The motive behind reserve accumulation differs across countries and varies over time; (ii) It is no longer a precautionary balance to absorb shocks; and (iii) The inflow of speculative capital seems to have been a significant factor behind reserve accumulation. More importantly, there is strong evidence of asymmetry in official intervention in the foreign exchange market in the sense that the amount of official purchase of foreign exchange in response to appreciating currency is larger than the amount of selling in response to depreciating currency of the same magnitude. This evidence confirms the fact that high reserve holding countries have the fear of currency appreciation. Although such fear is often attributed to possible export loss, it is largely due to the loss in terms of fall in the value of given stock of reserves due to currency appreciation.

 
 
 

In recent years, monetary authorities of the developing countries and some of the developed countries have accumulated a huge amount of foreign exchange reserves. The developing countries hold a share of about two-third of the world’s total foreign exchange reserves as evident from Figure 1. The tendency of this reserve accumulation mainly triggered after the recurring financial crises in the developing countries owing to inadequate stock of forex reserves (Figure 2). For instance, India went through a severe balance of payment crisis in the year 1991. During this period, the volume of reserves declined to US$4.7 bn which was not sufficient to cover even four weeks of import bills. Similarly, Russia in 1998 could not maintain its pegged exchange rate and defaulted on its debt obligations largely as a consequence of low level of reserves.

 
 
 

Applied Economics Jouranl.