Global Reserves’ Ingrained Erosion Tread

Since mid- 2015 through February emerging market foreign exchange reserves tumbled another $650 billion to $8.5 trillion including China as valuation effects have disappeared with the softer dollar, according to JP Morgan research. The mainland accounted for $500 billion of the loss as the industrial world $2.5 trillion total was steady. Commodity prices continued to decline but the main driver was risk aversion reflected in persistent private capital outflow. Positions fell in Hungary, Malaysia, South Africa, Turkey and Brazil the past year and a half, while Russia, Chile, Peru and Thailand started to recover. Korea, Mexico and Poland were solid until recent weakness. China’s monthly drawdown improved from $100 billion and turned positive in April with a $7 billion gain, but the cumulative drop the past two years is 20 percent to $3.2 trillion, and the capital account reduction is estimated at $700 billion by end-2016, which will be only half covered by the current account surplus. India in contrast continues to rise on reduced commodity important costs and a foreign direct and portfolio investment spike following Modi administration liberalization policies. Fluctuations in the leading reserve currencies like the euro, yen and pound along with the dollar no longer have a net impact, whereas from mid- 2014/15 they explained almost the entire reversal. While trade balances remain in surplus following the developing economy trend over the last decade and a half, capital inflows that had accompanied it became the opposite, and domestic banks and companies also unwound debt exposure and trading positions based on exchange rate appreciation assumptions.

 The $1 trillion outflow in the year to February was twice the blow experienced during the 2008-09 global financial crisis, the analysis remarks. With the oil price plunge Middle East central bank holdings are off $200 billion, but the reduction represents just 15 percent of the universe. Russia as another top producer and the rest of OPEC lost another $325 billion, still less than one-third the total since 2014. Should commodity values stabilize, reserves could rebound 5-10 percent as both earnings and global risk appetite return. IMF adequacy measures show most core countries above the 100 percent of external short-term debt and four months imports thresholds, although Argentina and Chile are at the margin. Broader standards that include M2 and portfolio liabilities put Asian members China, India and Malaysia in danger. China’s story remains murky as it reports only $1 trillion in reserve breakdown under its new statistical transparency commitment from SDR inclusion. The dollar and euro global reserve shares were 65 percent and 20 percent at end-2015, with the yen constant and the Aussie dollar and pound up marginally before their respective election and EU referendum calls.

UK departure in the June vote would eventually slash cohesion funds available to Eastern Europe members like Hungary and Poland, and the latter would also be hit by immigration restrictions with the large community of expatriate service workers there. British citizens in turn would face open-travel curbs on the continent, which could divert them to Mideast tourist destinations provided political tension subsides on their own issues.