Reserves Management and FX Intervention

Abstract

In line with this year’s topic for the Annual Meeting of the Emerging Market Deputy Governors, the Bangko Sentral ng Pilipinas shared its views and insights on three interrelated issues: (1) drivers of reserve accumulation from a policy perspective; (2) strategies, tactics and motivations of FX intervention; and (3) FX reserve management practices.

Specific to the first issue, reserves are held for four main reasons, according to the IMF: transaction, insurance, precautionary and investment. In the case of the Philippines, one of the reasons why the BSP accumulates reserves is to maintain the international stability and convertibility of the Philippine peso (Section 65 of Republic Act 7653). During periods of exchange market pressure or when the local currency is under attack, the BSP normally provides liquidity to the market settled via spot or non-deliverable forwards (NDFs). However, the build-up of reserves comes at a price, which includes sterilisation costs, actual or potential exchange rate valuation losses, the opportunity cost of foregone consumption or investment, and the costs arising from the maturity mismatches between reserves and sovereign liabilities. It is, therefore, a challenge for the authorities to manage reserves carefully in order to balance the costs incurred with the benefits.

The BSP’s participation in the foreign exchange market is limited to smoothing out volatility, or tempering sharp fluctuations in the exchange rate. When such movements are excessive, the BSP enters the market mainly to maintain order and stability. When warranted, the BSP also stands ready to provide liquidity and ensure that legitimate demands for foreign currency are satisfied. It is important to underscore that the overall strategy of the BSP is to allow the exchange rate to be market-determined.

On reserve management, the BSP tranches its reserves so that investment management can be aligned with the various objectives of reserve management, ie ensuring the availability of sufficient foreign exchange liquidity for day-to-day operations; generating income over the medium to long term and diversifying while maintaining acceptable risk exposures. Since the financial crisis, there has been an increased effort to further strengthen the risk management framework, which includes intensifying market surveillance, promoting investment compliance monitoring and conducting periodic stress testing and scenario analysis on the reserves portfolio.

Full Publication: Reserve Management and FX Intervention

Keywords: Bangko Sentral ng Pilipinas, motives for holding reserves, FX intervention, tranching of reserves

JEL Classification: E58, F31