Academic journal article International Journal of Business and Society

The International Reserves Holding and Country Risk: Evidence from Selected Asean Countries

Academic journal article International Journal of Business and Society

The International Reserves Holding and Country Risk: Evidence from Selected Asean Countries

Article excerpt


This paper extends the empirical literature on the relationship between the country risk and the demand for international reserves in selected ASEAN4 economies, namely Malaysia, Indonesia, Thailand and the Philippines, for the period 1980 to 2006. The empirical findings reveal that the fiscal position and stock of external indebtedness have a huge impact on a country's decision to hold international reserves. In addition, the results also find that Indonesia, a country with the highest risk in terms of economic and financial sectors, has taken corrective measures to deal with any sudden shocks.

Keywords: International reserves, self-insurance motive, country risk

(ProQuest: ... denotes formulae omitted.)


The international reserves held by most of the ASEAN4 countries have increased dramatically since the Asian financial crisis of the late 1990s. With high capital mobility and financial integration in the economy, self-insurance has emerged as the motive for holding international reserves that were traditionally for buffer stock. Figure 1 documents such an upward pattern in the stock of international reserves held by the ASEAN4 countries for the period 1980 to 2009. By the end of 2009, Thailand, Indonesia, Malaysia and the Philippines had accumulated international reserves of about 9.82, 6.14, 7.24 and 8.73 months of imports, respectively. The stock of international reserves held by the ASEAN4 countries has increased tremendously and exceeds the optimum level stated by the conventional rule, which is 3 months of imports. This raises the issue of a country's motivation for holding too large a stock of international reserves.

On the other hand, according to the country risk guide published by Political Risk Services Group, the ASEAN4 countries are ranked among the top 80 countries that have been rated in terms of total country risk condition.1 This indicates a condition of uncertainty and vulnerability for some ASEAN4 countries. As such, this condition of vulnerability could potentially explain the countries' behaviour in saving too many international reserve assets in the late 2000s.2 Besides that, greater financial integration leads to an increase of international reserves-holding that aims to reduce the incidence of costly output decline as induced by sudden reversal of short-term capital flows (Aizenman, 2008).

There is a limited but growing body of analysis related to the issues of international reservesholding by the ASEAN4 countries (Iyoha, 1976; Aizenman and Marion, 2004; Ramachandran, 2004; Aizenman and Lee, 2005; Aizenman et al., 2007; Aizenman, 2008; Choudhry and Hasan, 2008). By the same token, the relationship between the instability condition and the demand for international reserves has been discussed in several studies (Distayat, 2001; Aizenman and Marion, 2004; Aizenman et al., 2007; Zhou, 2009).

An early study conducted by Frenkel and Jovanovic (1981) analyzes the relationship between risk and international reserves. Based on the principles of inventory managements, Frenkel and Jovanovic (1981) develop a model that emphasizes the roles played by the stochastic characteristics in external transaction and the forgone earnings. The results show that the optimal money-holding is determined by rate of interest, mean rate of net disbursement, the cost of portfolio adjustment and the variance of the stochastic process governing net disbursements. On the other hand, the paper intuitively highlights the role of uncertainty (risk) in external transaction and opportunity cost. Aizenman and Marion (2004) examine the association between sovereign risk and demand for international reserves. The result shows that political instability and corruption factors play important roles in determining the optimal reserves-holding. In addition, there is evidence that the debt to reserves ratio is not a good predictor of vulnerability condition. Subsequently, higher uncertainty in the political conditions is associated with a higher probability of losing power, thus leading to the reduction in the savings of foreign reserves in the economy (Alesina and Tabellini, 1990). …

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