Sweden's Riksbank to Increase Reserves

Marc To Market's picture

The accumulation of reserves is primarily limited to developing countries.  There are two notable exceptions among the high income countries. Japan, which is traditionally willing to intervene in the foreign exchange market to curb the yen's strength.  The last intervention took place in Oct-Nov 2011, when the BOJ bought over $100 bln.  


The other exception is the Switzerland, where the SNB has capped the franc against the euro, leading to something on the magnitude of tripling their reserve holdings.  


The announcement that Sweden's Riksbank will boost its reserves drew our attention.  The Riksbank currently holds about $40 bln worth of currency reserves.  It will boost it by about 37% or around $15 bln (SEK100 bln).  The reasons behind its decision is interesting and reflective of more modern thinking about currency reserves. 


Classically, domestic money supply growth was a function of reserve accumulation.  However, since the end of Bretton Woods, reserves helped insulate country from a cut in exports and/or a surge in imports.  Sufficient reserves for a country, like mortgage/rent "rainy day" fund for a household, were thought of in terms of several months of coverage of imports.    


Beginning with the Asian financial crisis in the 1997-98, reserves began to be thought about in the context of short-term foreign debt obligations by the financial sector.  It seems that in is in this context that the Riksbank's move should be understood, though it made some passing reference to increased commitments to the IMF.  


The Riksbank's decision to increase reserves should be understood as a form of self-insurance.  The risk that needs to be insured against is something that Swedish officials have repeatedly discussed:  Domestic banks are too dependent on shot-term funding in foreign currencies.  The central bank then "needs a sufficiently large foreign exchange reserve to be prepared, if necessary, to provide banks with liquidity in foreign currencies."  


It is not just the central bank, but the government as well may take action.  Finance Minister Borg is strongly advocating stricter capital requirements on domestic banks that could cap their foreign currency borrowings.  This could be understood as a macro-prudential measure and could be a species of capital controls.  To be clear, the purpose is not to protest the krona's exchange value.  It is not a shot in what some suggest is a currency war, which I argue is grossly exaggerated. 


Separately, the Riksbank is expected to cut rates as early as next week (Dec 18)  The economy has weakened and according to a central bank survey, inflation expectations are subdued, below the 2% target.   Some local banks expect a follow up cut in mid Feb, when it meets again, as well.