Reserve Adequacy
Reserve adequacy is the judgement of whether a country's foreign exchange reserves are large enough for the shocks it could plausibly face. It is assessed with several ratios together, because no single number captures every way reserves can drain.
Also called: reserve adequacy assessment · adequacy of reserves · ARA metric
Three measures are used most. Import cover asks how many months of imports reserves can fund, with three months as the traditional floor. The Greenspan-Guidotti rule asks whether reserves cover all external debt falling due within a year. A third compares reserves with broad money, as a proxy for how much residents could try to move abroad in a panic.
The IMF combines these ideas in a composite metric for emerging markets that weighs exports, short-term debt, other external liabilities and broad money, and treats reserves of roughly 100 to 150 percent of the result as adequate. The weights differ for fixed and floating exchange rates, since a peg needs more ammunition to defend.
Adequacy is a leading indicator for payments. Countries judged short of reserves tend to respond with capital controls, surrender rules for exporters and queues for foreign currency well before any formal crisis.
In practice
Adequacy metrics are guides to judgement. A country can pass every ratio and still suffer a run if its reserves are not usable or confidence breaks for political reasons.
See also
- Import CoverImport cover is the number of months a country could keep paying for its imports out of its foreign exchange reserves if no new foreign currency came in. It is the simplest measure of how long a country can withstand an external shock.
- Foreign Exchange ReservesForeign exchange reserves are the foreign-currency assets a central bank holds and can use at short notice: deposits and government securities in major currencies, gold, Special Drawing Rights and the country's reserve position at the IMF.
- Capital FlightCapital flight is the rapid movement of money out of a country by residents and investors who fear devaluation, inflation, confiscation, default or political instability. It drains foreign exchange reserves and often triggers the controls it was trying to escape.
- Capital ControlsCapital controls are government limits on moving money into or out of a country, or on converting its currency at the official rate. Imposed by a central bank or finance ministry, they determine whether a payment corridor is workable at all, and in which direction.
- Currency PegA currency peg is a policy under which a central bank fixes its currency's exchange rate to another currency or a basket and stands ready to buy and sell at that rate. The peg lasts only as long as the reserves and credibility behind it.