Foreign currency reserves .. Its importance and some of the results of the truncation of it

Foreign currency reserves .. Its importance and some of the results of the truncation of it




07/01/2013 (23:00 pm)


D. Sinan Mohammed Rida Al-Shabibi *
There is no doubt that the government is responsible for fiscal policy in the economy. In contrast, the Central Bank is responsible for monetary policy, any actions that determine the size of the money supply and conditions in order to neutralize inflation and helping to provide a stable economic climate. There are undoubtedly problems plague the relationship between these two powers, especially if they are absent coordination between them.
Goal here is not to go into the details of these topics, but we want to focus on one subject, is of foreign currency reserves or the cover of the national currency. The root of the problem in this area focus on the belief of some, especially within government agencies, that the cover of the national currency is no different from treasury resources.
Have to make clear these things even though he wrote about a lot in the international economic literature and critical studies.
The reserve currency or cover consists result of community economic relationship with the outside world. Iraq has commercial and economic relations and financial capital with world within the so-called balance of payments, and the sum of these relationships is simply the change in currency reserves, which is added to the central bank's assets, which consist mainly of the reserve balance. This reserve, which is a foreign currency, the central bank buys the Iraqi currency to go to the asset side of the balance sheet of the Central Bank, and be issued currency for trading and banks in the liability side of the balance sheet of the Central Bank. In practical terms this reserve consists by the financial authority or government to buy the dinar from the Iraqi Central Bank to pay him after the dollar, which is the reserve.
We can interpret the reserve in two main ways:
First hand: it covers the currency issued by the Central Bank to the public and to the banks, the central bank of Iraq is in fact owe to the Iraqis who have this currency.
Second point: it can be seen that reserve cash balance which could be financed import for as long as possible when production stops or stops generating financial resources fully as a result of wars and disasters. If the central bank does not aim from behind to keep this up to prevent resources from the government, but to be this reserve ready "for use in a major crisis which can be exposed to the country and prevent generate financial resources for the country. We are talking about reserves or cover currency should not be to go out to the concept of savings within the national accounts. reserves resembles a foreign currency reserve framework of the car, which is only used when the car stops as a result of a hole in one of the tires, for example.
The issue of the size that can be the country needed from this reserve depends on the government's request, the private sector of the dinar in general, the more demand for the dinar by the government essentially brings the size of the reserve, and as the demand for the dinar is linked to economic activity in general, the amount of reserves and increase longer an indication of increased economic activity.
On the other hand the size of the reserve, which must be held by the central bank depends on the possibility of financing, for as long as possible, all imports in the event of a crisis or a disaster depends on the specific impact of production and the flow of financial resources. At present Iraq has funding for the import period (7) months if production stops, that is enough reserve for (7) months of imports. Such term gives flexibility to find solutions negotiator on the cessation of production and imports, and the scheme should always expect the worst conditions, and thus cautious for as long as possible. A key feature of the Iraqi economy is its openness and its dependence on the outside fully requiring surrounding it dramatically.
What happens when they are acting for the purposes of reserve does not fall within the objectives of the Central Bank? .. We will show that in the following:
The cutting off part of the reserve of the Bank's balance sheet should lead to a similar deduction from the liability side, and this latter deduction is not easy as some people think, it is required to withdraw a similar part of the currency in circulation is prepared to lend funds in different banks. There is no doubt that this will lead to a deflationary situation does not help in the growth, or so they can be to reduce the monetary issuance, any failure to meet the requests of the government of the local currency for a future period is not known, and therefore that what the government takes from the reserve can not afford to lose as the local currency. The bank has intentionally to raise the exchange rate (raising the value of the Iraqi currency) to reduce the demand for them. Finally had so they can be to make up the shortfall in assets in local currency, and this means a new version cash to cover the deficit, which have inflationary implications, because a result, there will be a demand not matched. The reserve here will not carry the meaning of the cover, so the currency will lose part of the protection and the central bank would lose its effectiveness in achieving economic stability necessary for development.
The cutting off part of the reserve weakens the ability of the central bank and its flexibility in the fight against inflation, and will then tighten monetary policy to counter inflationary conditions, which hinders the development efforts of the private sector in particular. The central bank is watching inflation developments continuously determines monetary policy in the light of this basis. Because of the sensitivity of the monetary sector, any manipulation of the asset side of the balance sheet does not give confidence to author of monetary policy in the formulation of this policy, and thus we will be in front of a high degree of uncertainty in the formulation of monetary policy tools, where we turn to change constantly, which leads to a state of uncertainty on the economic level, in general, and thus have a negative impact on development and investment environment.
C - The cutting off part of the reserve will affect negatively on the sale of foreign currency window at the central bank, which the bank will pay to reduce this sale or tighten its policy in this area, leading to the instability of exchange rates. The private sector, of course, depends largely on the window and determined economic activity through.
D - in conditions of uncertainty in which we live now, regionally and internationally, the central bank must maintain with high reserve exceeds the level of demand for foreign currency because of these circumstances, especially as the Iraqi economy is an open economy to the outside is what makes the external conditions significantly it. Should the central bank that have a high degree of stability policy maker can work safely operate.
E - The use of the reserve which is owned by the central bank to defend the exchange rate is to ensure price stability, which is essential for development. Some have commented that the economic activities carried out by development agencies are also working to stabilize prices. This is true, but the stability that we are talking about and the focus of the central bank is short-term stability, which is achieved through cash management application tools that are short Bomayora. This time dimension of stability you need development and other economic activities.
And - ensure the stability of prices and the exchange rate is essential for financial stability which is achieved by brokerage that are not exposed to fluctuations. The central bank's contribution to financial stability and ensure price stability, provide a way to implement a supervisory system for banks and financial sector institutions from developing and the basic function of the central bank as lender of last resort to save banks from collapse.
G - The deductible portion of the weakening of the reserve force central bank interventions in the money market. Must be the central bank in a stable position to be able to formulate policy securely and provides confidence to the banking system.
- The central bank fights inflation through his window of hard currency and withdraw the dinar, and this is a critical process. Then that the foreign currency purchased used in the provision of commodity supply, and this is a real process. These stages will certainly be affected deduct part of the reserve. It is important to emphasize that the window of foreign currency is monetary policy, not trade policy despite the fact that resources currency auction is mainly used to finance private sector trade.
* Central Bank Governor article


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