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Global reserve management (research in progress) SEMINAR Warsaw School of Economics 26 April 2007 Dr Krzysztof Rybiński* National Bank of Poland Deputy.

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Presentation on theme: "Global reserve management (research in progress) SEMINAR Warsaw School of Economics 26 April 2007 Dr Krzysztof Rybiński* National Bank of Poland Deputy."— Presentation transcript:

1 Global reserve management (research in progress) SEMINAR Warsaw School of Economics 26 April 2007 Dr Krzysztof Rybiński* National Bank of Poland Deputy Governor Blog: * Views presented during the seminar are my own and they do not necessarily represent the official position of the National Bank of Poland or the Financial Services Authority

2 Rybinski.eu Research motivation Huge, unprecedented reserves growth in recent years, well in excess of standard central banks needs in many emerging markets Huge, unprecedented reserves growth in recent years, well in excess of standard central banks needs in many emerging markets Observed change in central banks’ asset management strategy (new, global approach). Why? Observed change in central banks’ asset management strategy (new, global approach). Why? Assessing implications for the global economy and global financial markets Assessing implications for the global economy and global financial markets The end of US „exorbitant privilege”? The end of US „exorbitant privilege”? Implications for the NBP asset allocation strategy Implications for the NBP asset allocation strategy

3 Rybinski.eu Growth of Official Reserves Developing and Emerging Economies, USD bln. Sources: BIS, IMF

4 Rybinski.eu Growth of Official Reserves – selected countries Source: IMF USD m

5 Rybinski.eu Top Five Reserve Holders Source: IMF, RBS USD m

6 Rybinski.eu Sources: IMF IFS, IMF DOTS Growth of Official Reserves – Oil Exporting Countries

7 Rybinski.eu Reserves Adequacy: Months of Imports Developing and Emerging Economies, Weighted Average Sources: BIS, IMF

8 Rybinski.eu Reserves Adequacy: Months of Imports – Selected Countries Sources: IMF IFS, IMF DOTS, WDI

9 Rybinski.eu Reserves Adequacy: Reserves to M2 Ratio Sources: IMF IFS, WDI, NBP

10 Rybinski.eu Reserves Adequacy: Short-Term Debt Coverage Developing and Emerging Economies, Weighted Average Sources: BIS, IMF

11 Rybinski.eu Reserves Adequacy: Short-Term Debt Coverage Sources: IMF IFS, BIS-IMF-OECD-WB USD m

12 Rybinski.eu Growing Excess Reserves Source: IMF

13 Rybinski.eu Excess Reserves Above Short-Term Debt – Selected Countries Sources: IMF IFS, BIS-IMF-OECD-WB USD m

14 Rybinski.eu XX century investing vs. XXI century investing by CBs Very conservative central bank, capital protection strategy GIC, 9.5% pa. Source: World Bank Treasury

15 Rybinski.eu Global and US 1970 onwards US Only Global Source: World Bank Treasury

16 Rybinski.eu Probability of Negative Real Return 1-yr Holding Period 5-yr Holding Period 10-yr Holding Period 25-yr Holding Period Stocks32.3%21.9%13.3%0.0% Typical Pension Portfolio 33.2%18.4%12.5%0.0% Typical Central Bank Portfolio 34.8%32.8%37.0%38.1%

17 Rybinski.eu 100% Govt 1-3 Yr Portfolio vs. 50% Broad Fixed Income, 50% Equities Source: World Bank Treasury

18 Rybinski.eu Cumulative Return On a Typical Portfolio Source: Own calculations based on Merill Lynch Indices

19 Rybinski.eu Cumulative Return for the Previous Five Years Source: Own calculations based on Merill Lynch

20 Rybinski.eu Financial Malpractice “Is it financially responsible to invest accumulated reserve assets only in short-term liquid securities of industrial countries?” “Is it financially responsible to invest accumulated reserve assets only in short-term liquid securities of industrial countries?” “A university with a substantial endowment that invested its resources only in Treasury bills would be guilty of financial malpractice. A corporation with significant pension liabilities that invested its pension fund only in short-term financial investments would be guilty of financial malpractice. A state and local government in the United States, with substantial liabilities to its retirees that invested only in short-term financial instruments would be guilty of financial malpractice.” “A university with a substantial endowment that invested its resources only in Treasury bills would be guilty of financial malpractice. A corporation with significant pension liabilities that invested its pension fund only in short-term financial investments would be guilty of financial malpractice. A state and local government in the United States, with substantial liabilities to its retirees that invested only in short-term financial instruments would be guilty of financial malpractice.” - Larry Summers, September 14, 2006, Bank of Korea and World Bank Treasury Forum on Foreign Currency Reserves Management, Seoul, Korea - Larry Summers, September 14, 2006, Bank of Korea and World Bank Treasury Forum on Foreign Currency Reserves Management, Seoul, Korea Source: World Bank Treasury

21 Rybinski.eu Opportunity Costs If the wealth tied up in reserves were invested in a fully diversified long-term way in global capital markets, the resulting gain would be close to $100 billion a per year. Aggregating the 10 leading holders of excess reserves, the opportunity cost comes to 1.85% of their combined GDP… If the wealth tied up in reserves were invested in a fully diversified long-term way in global capital markets, the resulting gain would be close to $100 billion a per year. Aggregating the 10 leading holders of excess reserves, the opportunity cost comes to 1.85% of their combined GDP… ….This is comparable to the gains thought to be achievable from the next round of trade liberalization, to global foreign aid or to spending on key social sectors in a number of countries ….This is comparable to the gains thought to be achievable from the next round of trade liberalization, to global foreign aid or to spending on key social sectors in a number of countries --Larry Summers, March 24, 2006 L.K.Jha Memorial Lecture Reserve Bank of India Source: World Bank Treasury

22 Rybinski.eu Source: Central Bank of Latvia

23 Rybinski.eu CBs internal constraints. Example – bad incentives Base Salary Pat on the Back Bonus Bigger Bonus Maximum Bonus Concern Headache Migraine Screaming Fired Jail Source: World Bank Treasury

24 Rybinski.eu Dochodowość aktywów i pasywów NBP 2005 rok - dane przybliżonePLN mld Procent aktywów/pasywów ogółemDochodowość Aktywa - rezerwy % Pasywa - gotówka % Pasywa - zobowiązania wobec MIF % Pasywa ogółem (główne kategorie) %

25 Rybinski.eu Cost of holding large reserves (on top of sterilization rate premium)

26 Rybinski.eu Amid rising (opportunity costs) bentral banks get over bad incentives and accept more short-term risk for the benefit of higher long term return Maximization subject to policy and legal constraints

27 Rybinski.eu Examples (reducing USD) NBP has reduced USD share in reserves in early 2006 and increased the share of GBP. NBP has reduced USD share in reserves in early 2006 and increased the share of GBP. It resulted in foreign exchange reserves level being higher at end-2006 by PLN750mln equivalent, and increased return in 2006 by 60 bps (higher allocation to appreciating currency) It resulted in foreign exchange reserves level being higher at end-2006 by PLN750mln equivalent, and increased return in 2006 by 60 bps (higher allocation to appreciating currency) Diversification strategy continued by NBP in 2007 as well Diversification strategy continued by NBP in 2007 as well

28 Rybinski.eu Examples 2007 issue of RBS Reserves Management Trends confirms that CBs are planning to gradually diversify across currencies and across asset classes, with 56% of survey respondents agreeing that CBs should invest in equities 2007 issue of RBS Reserves Management Trends confirms that CBs are planning to gradually diversify across currencies and across asset classes, with 56% of survey respondents agreeing that CBs should invest in equities China has created a new giant reserve management institution, it will receive an estimated by markets USD bn worth of reserves to invest in high yielding assets (including commodity funds, private equity, possibkly hedge funds), out of USD1200bn reserves held by PBoC-SAFE (State Administration of Foreign Exchange) China has created a new giant reserve management institution, it will receive an estimated by markets USD bn worth of reserves to invest in high yielding assets (including commodity funds, private equity, possibkly hedge funds), out of USD1200bn reserves held by PBoC-SAFE (State Administration of Foreign Exchange)

29 Rybinski.eu What are the implications?

30 Rybinski.eu US C/A deficits accumulated to large negative IIP Source: K.Rybinski „Globalizacja w trzech odsłonach”, forthcoming May 2007

31 Rybinski.eu Positive US income account puzzle Source: K.Rybinski „Globalizacja w trzech odsłonach”, forthcoming May 2007

32 Rybinski.eu Will US exorbitant privilege go away? Source: Gourinchas, Ray (2005) and IMF WEO, April 2007

33 Rybinski.eu Consequences of improvement in global reserve management (long- term)? US will loose exorbitant privilege US will loose exorbitant privilege Dollar will loose the status of world first reserve currency Dollar will loose the status of world first reserve currency Faster developments of financial markets in Asia, maybe leading to common „asian” Faster developments of financial markets in Asia, maybe leading to common „asian” Better allocation of assets globally leading to higher global growth Better allocation of assets globally leading to higher global growth Changes in relative valuation of asset classes (higher demand for more risky assets) Changes in relative valuation of asset classes (higher demand for more risky assets) Possibly higher short-term volatility Possibly higher short-term volatility RISK!? What if global event shuts off many markets, and liqudity is gone. Will CBs acting as good asset managers be able to act as lenders of last resort as well? RISK!? What if global event shuts off many markets, and liqudity is gone. Will CBs acting as good asset managers be able to act as lenders of last resort as well?

34 Rybinski.eu Some recent evidence of risk diversification Source: BIS quarterly, March Record low emerging market CDS spreads suggest significant reduction of credit risk in emerging markets relative to US corporate risk in the same credit category

35 Rybinski.eu Implications for the NBP Define the practical meaning of legal and policy constraints (e.g. ERM2) Define the practical meaning of legal and policy constraints (e.g. ERM2) Create a long-term vision of foreign asset management (in principle no assets should be excluded from such a vision – equities, FHF, credit derivatives) Create a long-term vision of foreign asset management (in principle no assets should be excluded from such a vision – equities, FHF, credit derivatives) Embark on change process to fulfill that vision, observing policy constraints Embark on change process to fulfill that vision, observing policy constraints Consider consolidated ALM approach Consider consolidated ALM approach


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