(This is an English version of Nivel Récord de Reservas del Banco Central, with two new paragraphs at the end).
During the last few weeks, a couple of important reports –one in the domestic financial ambit, the other in the international sphere–, both clearly linked and of great interest to assess our economic perspectives have not yet received the attention they deserve.
In the local ambit, it was announced that the Banco Central de Reserva del Perú (BCR) was holding a record $46 billion of foreign reserves. In the international ambit, the president of the US Federal Reserve, Ben Bernanke, declared that an excessive demand for American securities by Developing Countries accumulating dollar reserves contributed to generate the current financial crisis.
Bernanke´s argument is very simple: as developing countries hold most of their reserves in financial assets issued by the US Treasury and American corporations, an excessive increase in their foreign reserves involves an excessive increase in the supply of credit to the US, funds that subsequently American banks cannot intermediate in an efficient way. This can be seen as a global economic cost of the accumulation of foreign reserves by developing countries. However, there can be costs derived from the accumulation of reserves by the BCR that directly affect our economy.
An apparent cost that we should ignore is the one concerning the inflationary effect that would result from the increase in the supply of soles brought about by the buying of dollars (and the selling of soles) by the BCR. We can disregard this possibility because the BCR sterilizes the effect of its interventions in the foreign exchange market selling bonds (certificados de depósito) to reduce the amount of soles in circulation. In this way, when it exchanges soles for dollars, the BCR is simply changing the composition of total liquidity in favor of the domestic currency. In effect, the dollar participation in total liquidity has fallen by one half in the last 6 or 7 years.
A first real cost of importance results from the fact that most of those $46 billion are invested by the BCR in dollar-denominated foreign assets that do not only pay very low rates of return, but also face the risk of a depreciation of the dollar, a tangible possibility because it is the American government the first interested in bringing about such depreciation, as it may be the only way it will find to close the current account deficits the US has been running for three decades now, and also of making possible the payment of a (dollar-denominated) public debt that now amounts to more than 100% of its GDP.
A second actual cost of the policy of accumulating foreign reserves results from the overvaluation of the dollar it induces. There is a cost because this contributes to increase –or to keep from falling– the profits of the mining corporations (and also of the drug-trafficking bands), to which the government refuses to apply the taxes they should be paying on the extraordinary profits they obtain from the extraction –and depletion– of our mineral resources.
Then, we should ask ourselves: Wouldn’t it be more reasonable to invest at least a portion of those reserves in infrastructure, public health and education in our country? At this time, this would be a less risky and more profitable form of investment, as the current configuration of the BCR’s portfolio is only a way to keep our scarce resources idle (something that may not please the author of the article on the “síndrome del perro del hortelano”).
Under these circumstances, it is surprising the indifference shown by purported defenders of the “invisible hand” of free markets, who do not appear to be bothered by the persistent intervention of the BCR in the foreign currency market. They can allege that high levels of foreign reserves are required to allow the BCR to intervene in the market in order to prevent abrupt variations of the exchange rate, and also as a way to earn the investors’ approval by providing an atmosphere of confidence.
However, this argument brings to mind the question of whether it is necessary to keep such a high level of foreign reserves. In effect, while the amount of the BCR reserves is equivalent to 160% of annual Peruvian imports, in the case of Colombia the corresponding figure is 67%, and in the case of Chile it is only 56%. It could be argued that, of the total amount of reserves, about $13 billion are basically obligations with domestic banks resulting from the reserve requirements on foreign-currency bank deposits, in such a way that the net amount of foreign reserves –the posición de cambio– is “only” $33 billion. But, even if we used this figure, Peru would still maintain its first place among the three countries. Besides, even the amount of foreign reserves held by Colombia and Chile may already be too high; and, if we make the comparison with rich countries, the Peruvian position is even more extravagant: the United Kingdom, France and Germany currently hold $50 billion in foreign reserves each.
Another objection –apparently a more reasonable one– would be that to spend (i.e., invest) a portion of the BCR reserves may cause inflation at a time when the economy is “overheated”. Well, to begin with, given that any type of investment is potentially inflationary because it increases the aggregate demand, the validity of this objection is relative. In any case, what is important is the type of investment we make and the way it is financed. For example, we could be in trouble if we needed to borrow or print money in order to finance it, but none of these is the case in the policy we are proposing. Besides, if the BCR refrains from buying dollars and accumulating reserves, the negative effect on the exchange rate would contribute to suppress any inflationary pressure.
Another objection –apparently also more reasonable– would be that, given the dollarization of the Peruvian economy, the BCR needs to maintain a rather high amount of foreign reserves. However, it would be very simple to show that such a need arises not as a result of a higher level of dollarization, but of (larger) increases in such level, which –as it has been pointed out– has been falling for several years now. We must also remark that the dollarization of the economy implies not only a larger demand but also a larger supply of foreign currency, since –besides the central bank– private banks also hold stocks of foreign currency. In any case, as it has also been pointed out, even the posición de cambio of the BCR seems to be excessively large.
Furthermore, in order to prevent abrupt variations of the exchange rate, there is a number of alternative instruments –less expensive than maintaining a high level of foreign reserves– that can be considered. One of them is a tax on foreign exchange transactions –as it has been suggested by James Tobin, a Nobel Prize in Economics– which would restrict the flowing of short-term, speculative funds. We can also consider the use of the BCR’s reference rate (tasa de interés de referencia) as an instrument that can help to keep the flow of funds under control. Another option is an appropriate handling of the ceiling on foreign investments by the private pension fund system, which is currently 30% and about to be increased to 50%. Still another option –pertinent if we accept that the level of dollarization plays a role– is the managing of the reserve requirement rate on dollar deposits in domestic banks.
Although the BCR’s obsession for buying dollars and accumulate foreign reserves may also be seen, up to a point, as a symptom or manifestation of the existence of a global excess liquidity –the European Central Bank has some publications concerning this issue–, it is also apparent that this policy does not make much sense, both because it is costly –as it entails keeping our scarce resources unemployed– and very risky –since it is very likely that the value of the dollar in the international markets will keep falling for some time.
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