Does Foreign Exchange Reserve Decumulation Lead to Currency Appreciation?
Many developing countries have increased their foreign reserve stocks dramatically in recent years, often motivated by the desire for precautionary self-insurance. One of the negative consequences of large accumulations for these countries is the risk of valuation losses. In this paper we examine the implications of systematic reserve decumulation by the Czech authorities aimed at mitigating valuation losses on euro-denominated assets. The policy was explicitly not intended to influence the value of the koruna relative to the euro. Initially the timing and size of reserve sales was not predictable, eventually sales occurred on a daily basis (in three equal installments within the day). This project examines whether these reserve sales, both during the regime of discretionary timing as well as when sales occurred every day, had unintended consequences for the domestic currency. Our findings using intraday exchange rate data and time-stamped reserve sales indicate that when decumulation occurred every day these sales led to significant appreciation of the koruna. Overall, our results suggest that the manner in which reserve sales are carried out matters for whether reserve decumulation influences the relative value of the domestic currency.
We thank the Czech National Bank, particularly Governor Zdenek Tuma, for access to the official intraday reserve sales data and for very helpful discussions. We have also benefitted from discussions with Karel Bauer and Petr Frydrych of the Czech National Bank. An early version of the paper was presented at the Bank of Japan, the Federal Reserve Bank of St. Louis, and the IMF, we thank seminar participants for very useful comments. We are grateful to the International Policy Center at the Ford School of Public Policy for financial support and Fatum gratefully acknowledges funding from Social Sciences and Humanities Research Council of Canada (SSHRC). Thomas Bridges and Brian Wojcik provided outstanding research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
“Do Sales of Foreign Exchange Reserves Lead to Currency Appreciation?” with Rasmus Fatum and Pavel Vacek, Journal of Money, Credit and Banking , vol. 45, 5, 2013, 867 ‐ 890.