Notes From a Native Son: It is Urgent We Discuss What to do About Our Foreign Reserves

Hal Austin

Hal Austin

Introduction:
One of the challenges of a small economy in a global landscape that is deep in crisis is the need for news ways of thinking. And, a self-inflicted deadweight that has fallen upon most small economies is the over-whelming desire to accumulate excess foreign reserves. The debate that is taking place among leading economists and policymakers about a more sustainable use of excess reserves and the social cost of warehousing such piles of money has created its own library of literature.
(For those of you who are interested, see, for example: Cedric Achille Mezui, Uche DuruCedric: “Holding Excess  Foreign Reserves Versus Infrastructure Finance: What should Africa Do?” African Development Bank Group. Wijnholds and Kapteyn: “Reserve Adequacy in Emerging Market Economies”, IMF, 2001. #Dr Courtney Blackman, “Managing Foreign Exchange Reserves in Small Developing Countries,” Group of 30, 1982). There is a strong case against the fetishising of foreign reserves when a stagnant economy is crying out for urgent and strong stimulation.

Infrastructure:
Financing infrastructure, for example, which in an economy like Barbados is badly in need of upgrading, there must be new ways of raising funds without adding to national debt and without entering private/public partnerships which would only hold the nation to ransom. What is badly needed is deeper financialisation, particularly from non-banking sources, to fund small and medium enterprises and, more so, infrastructure developments. One possible source of such funding is excess foreign reserves, the build up of which has attained an almost obsessive cult following among some policymakers. However, to clarify this there is a need for a widespread national debate on what is an adequate level of foreign reserves.

Foreign reserve policy is usually based on two theoretical methodologies: import hedging and the so-called Wijnholds and Kapteyn method (see above). There are two other equally attractive ways of managing foreign reserves: first, by estimating the social cost of warehousing such large sums of cash, based on the opportunity cost of investing in infrastructure and their percentage of GDP; and, investing in the commodities and currencies Futures Markets.

Infrastructure investments – funding the key structures important for the smooth running of the economy and society – are the key ways of increasing growth and productivity in an economy. Better roads mean that delivery trucks can travel farther and with relative safety to make deliveries to the far corners of the nation; better homes and schools, water and electricity supply, but by far the greatest loss to the economy is the lack of state-of-the-art technology right across government and the statutory bodies. Technology with the appropriate functionality, it can be guessed, could add anything from 0.5 per cent to 4 per cent to GDP in terms of productivity and efficiencies.

It is generally conceded that to stimulate growth it is important to invest strategically and put in place high-quality governance. Admittedly, infrastructure funding is usually prohibitively costly, but with careful planning this can often be met through a combination of sources, including a percentage of foreign reserves, bonds (institutional and retail), and the private sector, such as insurance and occupational pensions.

In Barbados, there are two major hindrances to progressive infrastructure developments: a lack of ideas by policymakers, and the reluctance of foreign-owned local banks to open a credit stream to for such developments. The other hindrance is the lack of fiscal incentives to lenders, banks and non-banks, for funding such important development projects. There is also the question of competence in terms of project appraisal methodologies and decision-making which can also delay projects.

For example, the government is spending over Bds$200m on acquiring Almond Resorts, and a further $160m on road works. This is money that could better be spent on improving the slum conditions in the City, rather than use more land, a scarce resource, in building roads to encourage greater motor vehicle ownership and use. It is a classic example of the need for strategic thinking since a well thought out urban plan would enhance the quality of life for those living in the City and, indeed, for visitors, including tourists, and small businesses such as the entertainment sector. One danger in funding an infrastructure project is the risk of asset/liability mismatch, since an infrastructure development -is a medium to long-term project.

Missed Opportunity:
In the final analysis, the August 13 Budget presentation by minister of finance Chris Sinckler was an exercise in failure. He abandoned any attempt to rebalance the economy, preferring instead to spoon-feed the private hotel sector on the misleading principle that since tourism is important to the economy these too form a major part of the economy. However, he missed an important principle. For example, agriculture has been important to humankind for the last 10000 years, but the productions methods have changed: we now have tractors in place of flint stone or wooden ploughs, we now have a highly scientific sector instead of trial and error.

Interestingly enough, there was nothing about household and corporate debt in his proposals, nothing about home ownership, nothing about job creation. In the absence of official figures – from the central banks, the banks trade body or the ministry – or unofficial ones from academics and policymakers, one is left to assume that household debt is multiples of annual salaries and we know about the non-performing corporate debt. All this is taking place against a backdrop of incredibly official inflation numbers – at under three per cent, including a massive commodity import bill, inflation export from China and above-inflation prices for good and services by local tradespeople. Further, as is generally known, inflation impacts on demographic groups differently, with the elderly coming off worst.

What clouds the Barbados economic landscape is that generally during a downturn there is a drop in productivity, but with 30,000 people on the public sector payroll, and a culture of minimal production, there is clearly no productivity improvement now or at anytime in recent years from the Barbadian public sector. The argument, often put forward by trade union apologists for this over-manning, is that the public sector is hoarding labour ie there is not enough for workers to do because of low demand, but no redundancies.

This is disingenuous. The continuing low productivity rate and inefficiencies are deep historical structural flaws in public sector management, mainly because since the Second World War, and in particular since constitutional independence, the public sector payroll has been used to soak up the unemployed queue. This became even more important since the migration routes to the UK, Canada and the US, have been greatly reduced. There is nothing about this that improvements in management systems, including the introduction of state of the art technology, could not remedy.

Analysis and Conclusion:
Although the key source of funding for major banks should be banks, other non-banking enterprises, such as Sovereign Wealth Funds, hedge funds and private equity, should not be ruled out. Another invaluable stream is the development of household savings, similar to that in the Asian economies. Of course, the main driver of Asian savings is because there is no expectation that the state will provide the generous social safety net that we have come to expect in the West. So, people are under no illusions that they have to save to provide for themselves and their families.

As Mezui and Duru (see above) have observed about the African economies: “….excess foreign reserves held by African countries can meet the infrastructure financing needs of the continent which has been estimated at US$93bn per annum,… “Investing just about 30 per cent of the excess reserves ($165 or $193bn) in investment vehicle for infrastructure will go a long way in meeting the financing needs of infrastructure in the continent…”

It is my case that we have to look long and hard at the foreign reserves and think of more socially and economically sustainable ways of using at least aw percentage of that money, including the servicing of national debt. The opportunity costs of stockpiling huge amounts of foreign reserves when compared with the developments such reserves could fund, is a decision for the people as a whole. But, as policy, when such reserves could be used to pare down debt, fund infrastructure or even a small retail bank which could help fund new businesses and households, it appears to be flawed.

101 comments

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  • This was written four years ago and is still relevant.

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  • Let us debate reserves.

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  • millertheanunnaki

    @ Hal Austin October 9, 2017 at 7:20 AM

    Thanks for finally reacting to my goading in your resuscitation of that 2013 topic.
    We all knew you had it in you but you were being just like squirrel hiding his ‘nuts’ like a candle of knowledge under a basket of darkness.

    But it’s a bit too late since the forex earning horse has long bolted from the foreign reserves stable.

    As far as forex is concerned Barbados is living from paycheck to paycheck to meet its day-to-day import needs. Payday loans to make ends meet are the order of the month.

    Where would Barbados get that amount of forex savings to play financial roulette unless it applies to the IMF to convert some its SDRs into hard currency?

    So you see Hal, no-one was or is taking your proposals seriously. Not even the Guv of the CB far less the MoF (Magus of Fools).

    If only that missing $300 million in FX could be found, what a wonderful day of an economic game-changer that would be!

    Get real, man!

    Barbados is not Singapore earning more than its way in the world and swimming in an ocean of foreign reserves or the Central African Republic awash in natural resources and foreign reserves ‘forcibly’ held in France’s Central Bank as reparations for the ‘benefits’ received from French colonialism.

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  • Jethro Miller,

    Thanks for finally reacting to my goading in your resuscitation of that 2013 topic.

    Please! Are you mad? It was David (BU) who, as you say, resuscitated’ this. I do not respond to threats, especially from bullies. I simply responded to the re-publishing.

    We all knew you had it in you but you were being just like squirrel hiding his ‘nuts’ like a candle of knowledge under a basket of darkness.

    I am afraid I am not looking for validation from you. It is simply not appreciated.

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  • millertheanunnaki

    @ Hal Austin October 9, 2017 at 10:00 AM

    You asked for a debate; not for an exchange of ad hominems.

    Now respond to the points made that show the irrelevance of your gambling proposals to the management of the Bajan foreign reserves situation.

    At least do it for the enlightenment of the BU readers (not the miller’s).

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  • Please! Are you mad? It was David (BU) who, as you say, resuscitated’ this. I do not respond to threats, especially from bullies. I simply responded to the re-publishing.

    This statement is false.

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  • David,
    You are being disingenuous. At the bottom of all your main contributions, under Related, you publish a number of links. Over the last few days you – or one of your assistants – re-published the link to my Notes..on one of the contributions (I cannot recall which one) and I responded to that. It is not false.

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  • You are a jackass.

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  • You are being supercilious to hide your economy with the truth.

    On Oct 8 at about 6.31pm on one of the post (you can do an audit) there was the above post from four years from me. I -re-read and,, apart from the typos, thought it still relevant and re-posted it (see below).
    After there was no reaction to it, the following day I did a search and re-posted it again with the comment: “Let us debate reserves.” (see below)
    You can verify all these by doing an audit trail. You are simply displaying your innate stupidity by portraying me as a fibber.
    If you had not flagged it up I would not even have remembered I had written it. Your convenient duplicity is rather interesting.

    Hal Austin October 8, 2017 at 6:31 PM #

    This was written four years ago and is still relevant.

    Hal Austin October 9, 2017 at 7:20 AM #

    Let us debate reserves.

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  • I understand Hal Austin’s arguments about countries accumulating EXCESS foreign exchange reserves and the benefits that can be derived from investing those excess amounts in infrastructural developments, etc.

    I also read the Working Paper # 178, July 2013: “Holding Excess Foreign Reserves Versus Infrastructure Finance: What should Africa do?”

    The following excerpt was taken from the “Abstract” of the paper: “This paper is a contribution to the debate on the use of EXCESS foreign exchange reserves from different African countries as one of the funding sources for financing infrastructure.”

    I capitalized “EXCESS” to emphasize the point that the working paper, as well as the other source materials suggested by Hal, deal with EXCESS Foreign Reserves.

    However, in MY opinion, I do not believe his arguments are applicable to Barbados, especially under circumstances where, over the years, the island has HELD to the “international benchmark” of 12 weeks of an adequate level of forex reserves. And to my knowledge, successive administrations have NEVER accumulated any HUGE AMOUNTS of forex that could be used for the investment opportunities or financing infrastructural development Hal Austin alluded to.

    Barbados has been basically STRUGGLING for years to MAINTAIN that “international benchmark,” far less HOARD excess reserves.

    The international rating and financial rating agencies, Central Bank of Barbados, economists, special interest groups, etc, often comment about the economic implications to the island, if the foreign reserves go below that “benchmark” for any considerable period of time.

    Additionally, Hal Austin has neglected to consider Barbados’ monetary policy and the fixed exchange rate regime.

    Barbados has a “fixed rate of exchange economy”……….. forex reserves basically allows the Central Bank to convert BD$ to foreign currency on demand.
    If, for example, the Central Bank is unable to meet the exchange rate demand of BD$2 for US$1, to facilitate foreign transactions, forex (inclusive of any fees) would have to be purchased from a “forex broker.”

    For example, because we import most of our consumption goods, the food import bill is high. Under these circumstances, consider the economic implications if we have to purchase forex from a “broker,” especially if the forex market becomes unstable.

    (The increasing price of food imports not only affects the budget through the demand for increased forex to purchase these goods, it also contributes significantly to “food price inflation.)”

    If we take into consideration Barbados’ high import bill and the struggle to maintain an adequate level of forex reserves, (the levels of which in recent years have been fluctuating), how can Barbados use its “LIMITED” (or “measly)” forex reserves to finance what Hal seems to be suggesting?

    However, I understand his comments, if they were made in reference to billion dollar economies such as China or India that can accumulate excess reserves.

    Many countries use the US$ as the main forex reserve currency, which is an “arrangement” that benefits the US. You may ask how. Suppose “country X” stockpiles US$500b, who benefits? The US………… because the $500b does not earn any interest for “country X,” and may facilitate an (interest rate free) expansion of the US’s monetary base.

    This is where Hal’s comments become interesting. “Country X’s” government could use a percentage (%) of the US$500b for investments and infrastructural developments, as suggested by Hal.

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  • I agree with Hal Austin’s comments in the section entitled: “Missed Opportunity” of his article.

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  • However, in MY opinion, I do not believe his arguments are applicable to Barbados, especially under circumstances where, over the years, the island has HELD to the “international benchmark” of 12 weeks of an adequate level of forex reserves

    What is the purpose of holding 12 weeks foreign reserves?

    Additionally, Hal Austin has neglected to consider Barbados’ monetary policy and the fixed exchange rate regime.

    I did not; it was to deal with the chaotic and misguided monetary policy and the unnecessary fixed exchange rate that I was making my proposal. That is why, previously I have said we should decouple from the Greenback, fix against a basket of currencies and commodities.
    The US is losing its place both as a trading power and as the holders of the dominant reserve currency.
    Who are out main trading partners? Our high import bill is just living above our means.

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  • The purpose of hold 12 weeks of forex reserves is beside the point.

    Your article dealt with countries that strive to accumulate excess reserves and the probable usage of those EXCESSES.

    This is where you should focus your response.

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  • “However, to clarify this there is a need for a widespread national debate on what is an adequate level of foreign reserves.”

    I agree there should be a “debate on what is an adequate level of foreign reserves.” I believe the international benchmark of 12 weeks reserves is too low.

    Dominica, for example, was recently devastated by a hurricane and would need a significant amount of forex to finance recovery. Hence, the 12 week benchmark would be inadequate under these circumstances.

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  • The reasons why economies hold foreign reserves is very important, you just cannot dismiss it. If you build reserves you must have an idea of what they are for.
    The entire article is about excess – that is why the proposal to use the money more creatively.

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  • 12 weeks too low????????

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  • In insurance it is called a once in a 200 yr event. It is sad that Dominica has been devastated, I love the country, but the entire re-building is not the responsibility of the government nor international donors.
    Dominicans – in fact the entire Caribbean – is hugely under-insured. I have said this on BU on a number of occasions.
    This runs from life cover, income protection, medical insurance, home and contents insurance to funeral expenses. We also badly need proper regulation to prevent the existing 20 or so companies from ripping off the public.

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  • It seems as though you do not read anything in its entirety.

    I presented the Dominica situation as an example why I believe it is too low to use as a basis to determine the “health” of an economy.

    And I have never read any statistical information that could justify the benchmark ratio.

    How can the 12 weeks ratio be adequately applied to our situation, when:

    ……….Similarly to all other Caribbean islands, Barbados is vulnerable to natural disasters such as hurricanes, floods, etc, while volcanic activity affects other islands. Under those circumstances, these islands will require more than 12 weeks of reserves. Dominica will obviously require more than 12 weeks because the recovery effort will be long termed. Then what about unregulated control of forex entering and leaving the island?

    ……….Barbados imports more goods and services than it exports.

    ……….You also answered the question in your article re: “……with 30,000 people on the public sector payroll.” Such a large public sector can have an effect on an island’s foreign currency consumption.

    And these are only three examples.

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  • “Then what about unregulated control of forex entering and leaving the island?”

    Should be example #4

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  • What is the foreign reserves for? Why 12 weeks and not 24 or six? In a situation such as Dominica, or any hurricane-affected nation, government has obligations and home and business owners have obligations.
    Business owners should have the necessary insurance, and should be claiming on that cover; and home owners should be claiming on their cover. Government’s responsibility is for the infrastructure and those people too poor to protect themselves.
    It is important that we know why we have reserves, apart from the fact that it has always been the case. A few months ago one of our leading economics professors, writing in the Nation, tried explaining why we needed foreign reserves, and failed. I assumed from that that if he did not know, then he could not teach his students what foreign reserves were for. In Barbados there is a certain level of groupthink, people repeat a mantra without really knowing why they repeat it. The notion of foreign reserves is one of those.
    But it is better to challenge all received wisdoms, ask questions: why is that? What if?
    What is so unclear about that?
    I will add for good measure. The worst post-independence attack on the medium and long-term welfare o the Barbados economy was the decision by Owen Arthur, our only trained economist to be prime minister (forget Sandiford, he was a teacher), to sell off BNB.
    That is what some of our foreign currency reserves should be used for, re-establishing a Barbados-domiciled bank.
    As to unregulated foreign currency being effectively legal tender in Barbados (ie the Greenback) that should be outlawed. I have said that in BU on numerous occasions.

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  • This argument still stands up.
    By the way, CityAm, a free UK paper, reports today (Wednesday):
    “Britain’s top accounting regulator yesterday revealed plans to tighten the leash on the nation’s biggest audit firms “to avoid systematic deficiencies within firms’ networks.”
    “The Financial Reporting Council (FRC) will set out its expectations of PwC, Deloitte, EY, KPMG, BDO and Grant Thornton….”

    Again, emphasising the point that the FRC is the regulatory body for accounting in the UK. By the way, I have a copy of UK GAAP which I want to off load since it is no longer of interest apart from being a historical document. Interested?.

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  • Written five years ago and still relevant.

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