The Importance of Foreign Exchange Reserves
The Importance of Foreign Exchange Reserves
Higher foreign exchange reserves will help Latin America to withstand global economic pressures.
An important lesson of the 2008–2009 financial crisis was that the emerging market economies with high levels of international reserves were better able to withstand the ripple effects of the global meltdown. In Latin America, the cases of Brazil and Mexico provide a clear illustration.
When Lehman Brothers went under in September 2008, Brazil had foreign exchange (FX) reserves of $205.5 billion—equivalent to 12.9 percent of GDP—while Mexico had $83.6 billion, or 7 percent of GDP. While the FX reserve levels easily covered a year of short-term debt maturities, Mexico’s were below the other precautionary threshold of six months of import coverage.
Brazil’s much higher level allowed its central bank (BCB) to more effectively respond. It intervened in the FX market to help stabilize the Brazilian real, provide FX swap lines to Brazilian corporations that faced difficulties rolling over U.S. dollar-
denominated maturities and assist exporters hit by the global dry-out of trade financing lines.
In contrast, Mexico’s central bank (Banxico) did not have the flexibility to support the Mexican peso and meet the surge in U.S. dollar demand from Mexican corporations. Overall, the strong FX reserves position was a key factor that allowed Brazil to adopt more aggressive countercyclical measures and emerge from a short-lived recession by the second quarter of 2009. Mexico had to endure a deeper downturn that lasted several quarters.
The explanation for the divergent tales of Brazil and Mexico is in their different balance-of-payment structures. On the current account front, 55 percent of Brazil’s exports are composed of commodities, which had surged in the years prior to the Lehman collapse and helped sustain a current account surplus. On the capital account front, Brazil’s high interest rates and booming economy had attracted hefty portfolio and foreign direct investment (FDI) inflows. All this allowed the BCB to more than triple its FX reserves between 2004 and 2008 amid heavy U.S. dollar buying to prevent excessive Brazilian real appreciation...
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Luis Oganes is the head for Latin America in the Emerging Markets Research Group at JPMorgan Chase & Co.
