A discussion on adequate and optimal level for international reserves

Whether developed, or developing, for almost all economies, holding prudent amounts of international reserves bring considerable advantages in conjunction with sound policies and fundamentals. Appropriate governance structure for foreign reserves and the determinants of foreign reserve demand are analysed in this study. Three types of indicators for foreign reserve adequacy are discussed in detail: ratio of foreign reserves to imports, foreign reserves to monetary aggregates, and foreign reserves to external debt. Three different approaches are used to uncover the factors behind the demand for foreign reserves. First, a precautionary approach named as Buffer Stock Model is employed. Then, asymmetry in volatility is evaluated as a determinant of reserves. Lastly, it is assumed that there may be no discretion regarding the level of reserves but it is a result of macroeconomic developments. It is found that high international capital mobility could not reduce the importance of volatility. While opportunity and replacement costs are also important, volatility is still an important determinant. Controlling for skewness underlined the importance of opportunity costs. Last attempt showed that real imports, volatility of balance of payments and average tendency of imports have both statistically and economically significant effects on the demand for foreign reserves.