Policy Briefing Series

  • 25.11.2009

    Official Reserve Adequacy in Ukraine: Assessment and Policy Implications


    At normal times, many people wonder why central banks, especially in emerging markets, keep vast amounts of official reserves, and they accordingly emphasize the (opportunity) costs of such holdings. However, in times of a financial crisis, the benefits of holding official reserves become evident. Reserves help to absorb external shocks, making the likelihood and the negative consequences of such shocks smaller.

    The main goal of this paper is to assess the adequacy of official reserves in Ukraine. Based on a thorough review of the relevant theoretical and empirical literature we select three standard criteria for such an assessment. The "classical" import coverage criterion, with its exclusive focus on foreign trade; the Guidotti-Greenspan criterion, which is based on short-term external liabilities of the country; and the Wijnholds-Kapteyn criterion, which was developed to catch the important phenomenon of "internal" capital flight, i.e. the conversion of domestic into foreign currency by residents.

    After explaining the economic reasoning behind the selected criteria, we apply all three criteria to Ukraine. As of the end of the second quarter of 2009, Ukraine held USD 27.3 bn of official reserves. This amount would be sufficient to cover 5.6 months of future imports, while the minimum threshold for this criterion is 3 months. However, the level of reserve holdings is clearly not sufficient to withstand an external financial shock, especially when accompanied with internal capital flight. Both criteria which measure this sufficiency (Guidotti-Greenspan and Wijnholds- Kapteyn, respectively) are below their respective minimum thresholds.

    To be better positioned for withstanding external shocks, Ukraine has to address both the supply and demand side of official reserve holdings. On the supply side, there is no doubt that Ukraine needs more reserves. Here, the continuation of the IMF program and the disbursement of the fourth and further tranches would be extremely important for Ukraine. Among general economic policy measures, the authorities should pursue a much more aggressive policy of structural reforms, FDI attraction, privatisation, and export facilitation to boost reserves.

    On the demand side, the NBU has to run a sound and credible monetary policy, limiting the expansion of the money supply and thus capping the internal capital flight. Moreover, structural reforms alongside with macroeconomic stabilisation should reduce the country risk score and thus restrain demand for reserves. Here again, the importance of the continuation of IMF program should emphasised as a centrepiece of macroeconomic policy.

    Authors:  Movchan Veronika, Кірхнер Роберт, Джуччі Рікардо
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