After Losing $1 Trillion, Central Banks Build Reserves Againby and
Reserves climbed $73 billion to $11 trillion in three months
Bigger reserves give central banks tools to cope with rout
Central banks in developing economies are taking advantage of the biggest rally in their currencies since 2010.
Led by Turkey and Thailand, they’re using stronger exchange rates to build up foreign reserves for the first time in two years, replenishing shortfalls created as they attempted to prop up their currencies during recent routs. Bigger defenses mean they’ll be able to better ride out destabilizing plunges as they make their economies more appealing for traders, according to investment firms including Manulife Asset Management and GAM UK Ltd.
International reserves have grown by $154 billion, or 1.4 percent, since the end of March to $11 trillion, according to data compiled by Bloomberg. Turkey’s cash coffer expanded the most during the period, increasing more than 6 percent. Thailand’s currency pile rose 5.5 percent, while Indonesia’s climbed 3.6 percent.
“If central banks have more firepower, investors are more likely to buy on dips,” said Richard Segal, an emerging-market analyst at Manulife Asset Management, which oversees about $130 billion in fixed-income investments. “Many were earlier concerned when international reserves became depleted, and therefore being able to replenish them will give bondholders more confidence.”
The increase marks a reversal since 2014 when capital outflows prompted central banks from China to Saudi Arabia to burn through hoarded cash to stem declines in their currencies. Global reserves peaked at $12 trillion in August that year and had been declining until recently when capital started to flow back into emerging markets.
With more than $10 trillion of bonds in Europe and Japan yielding below zero, developing-nation assets are becoming attractive for yield-starved investors just as their economies show signs of recovery.
A record $18 billion was added to emerging-market bond funds in the six weeks through Aug. 10, according to EPFR Global, which tracks fund flows. An improvement in current accounts, a broad measure of international trade and services, brings in additional dollar receipts. The influx of money helped the MSCI Emerging Markets Currency Index rise 10 percent since a low in mid-January, on track to the biggest annual rally in six years. The gauge was up 0.4 percent as of 9:01 a.m. in New York, reaching the highest since June 2015.
Central banks are absorbing some of these inflows by selling their own currencies. Turkey’s gross reserves increased more than $8 billion to $101 billion from a four-year low in January. After losing 32 percent of its reserves in the previous three years, Malaysia’s central bank boosted its coffers by $2 billion this year to $97 billion. Stockpiles in India and the Czech Republic have climbed to records.
Even in China, the world’s largest reserve holder, the cash pile has stabilized at $3.2 trillion after it fell more than $600 billion since the end of 2014 as investors pulled money out amid concern economic growth was slowing.
“More and more money is being put into emerging-market bonds and equities and it’s giving them opportunities to buy dollars and replenish reserves,” said Koon Chow, a London-based strategist at Union Bancaire Privee. “They have the means and motivation to do so.”
Part of the increase merely reflects valuation changes. As the greenback weakens, the dollar value of other reserve currencies, such as the yen, increases. But even when adjusting for the variation in valuations, foreign reserves among major developing nations grew by 1.1 percent over the past three months, according to Morgan Stanley’s estimate.
By accumulating reserves, central banks are preparing for potential disruption once the Federal Reserve raises U.S. interest rates, which may drain capital from emerging markets. Analysts surveyed by Bloomberg see the dollar reasserting itself in coming months, forecasting all major emerging-market currencies will weaken by year-end.
Analysts are most bearish on the South African rand, predicting it will drop 14 percent to 15.38 per dollar by Dec. 31. The Turkish lira, Brazil’s real and the Argentine peso may all depreciate at least 6 percent, according to the median forecasts of the strategists.
Historically, rising reserves won’t necessarily reverse the trend of emerging-market currency appreciation because the dollar purchases by central banks tend to be overwhelmed by capital flows from investors, according to Michael Biggs, a money manager who helps oversees more than $5 billion in emerging-market bonds at GAM.
A 60 percent increase in global foreign reserves in four years through 2012 coincided with a 26 percent gain in the MSCI Emerging Markets Currency Index. Rising reserves is “a good sign,” said Biggs. “It supports the fundamental story.”
For Morgan Stanley’s analysts, there’s another positive feedback loop for emerging markets from rising reserves. After buying dollars, developing-nation central banks typically use the proceeds to purchase bonds in advanced economies, such as the U.S. This helps keep Treasury yields low, pushing investors into higher-yielding assets in developing nations.
“EM FX reserves are rising in aggregate again, reflecting an improvement in capital inflows,” strategists led by James Lord wrote in a note dated Aug. 10. “We stay bullish on EM for now, as the yield differentials remain attractive.”