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Is the Size of Foreign Currency Reserves an Indicator of Economic Strength of a Country?

The amount of foreign currency reserves can be an important factor or signal of economic prosperity or power in a country, but not the only one. To illustrate, foreign currency reserves can help protect the value of local currency within a country especially in a developing country, but it is not enough alone to prevent depreciation of national currency against speculation or surprising events that may occur from time to time. However, good management of foreign currency reserves plus the overall general performance of national economy can be favourable or helpful in preserving the value of local currency as well as national wealth and savings. A Thriving and growing national economy can lead a country to form sufficient amount of hard currencies. For instance, South Korea, an East Asian country that is quickly industrialising and developing, has accumulated reserves reaching about 365 billion dollars in March 2016, which is praiseworthy in a country having recently a nominal GDP more than 1300 billion $. Foreign currency reserves can allow nations to borrow money or sell treasury bonds with less cost and higher credibility. In September 2016, South Korea could sell 10 year treasury bonds with interest rate 1.46 % just a little bit higher than % interest on US T-bonds, being currently considered as safe haven. Another example, Switzerland that has a population of almost 8 million, has owned in March 2016 foreign currency reserves of almost 607 billion $ (excluding Gold). This is no surprise as the Swiss banking sector is among the safest and strongest in the world. One example, UBS, one of the largest banks in Switzerland and even in the whole world, has managed in 2014 total assets of about 1,967 billion $. In general terms, Swiss GDP per capita or average annual individual income in 2015 has reached $ 75,550, among the highest in the world. Besides, its national Currency (Swiss Franc) is a safe haven. The Swiss Banking sector has helped historically in establishing infrastructure projects such as railways throughout Switzerland and Europe generally and so on. In conclusion, foreign currency reserves are part of financial resources that can help support national economy if well invested and correctly managed because they can support sustainable economic development and financial stability whether directly or indirectly.

Generally speaking, when foreign currency reserves expand in size, they could be one sign of positive economic events taking place. For example, from 2000 till 2008, Russia, which is the one of the largest exporters of oil and natural gas, had its foreign currency reserves increasing steadily after oil and gas prices climbed and prudent economic reforms were taken. Russian foreign currency reserves rose to a peak of 596.5 billion dollars in July 2008. The average annual income multiplied and increased dramatically during this period…Another example, Germany which is a great guarantor of the Euro currency (one of the reserve currencies of the world) has owned foreign reserves of almost 400 billion dollars in April 2016. Germany is the second largest exporter of goods in the world after China. The nominal GDP per capita of Germany has recently been estimated to be 3500 billion $ and GDP per capita reached about $ 42,000 recently. However, foreign reserves are not the only sign of economic prosperity. For instance, USA had foreign reserves of 120.4 billion $ in July 2016 less than Russia having 394 billion $ in July 2016, but this does not indicate that the Russian economy is larger or better than the US economy, for example. The US dollar itself constitutes the majority of the reserve currencies of the world, but the Russian Ruble is not considered a hard currency and is much less used in world trade than US dollar. In comparison, the US has the largest economy in the world having a nominal GDP of about 18,000 billion $ and a nominal GDP per capita about $ 51, 500 in 2015, whereas Russia had a nominal GDP of about 1,326 billion dollars and annual average nominal income of about 11,000 dollars in 2015. Russia has risen to become the 12th most innovative economy in January 2016 but the USA is reported to be the fourth most innovative economy in the world. It can be said that rules or norms have exceptions and special cases.

We go further to illustrate more about the issue of foreign currency reserves (not to mention Gold) and its correlation with economic development. China, becoming a middle income country, accumulated the globally highest foreign exchange reserves of 3,234 billion $ in March 2016 as a result of high economic growth 10 % annually for thirty years ( although economic growth slowed somehow in the recent few years ) . Moreover, China has a growing middle class in both number and average income due to economic and technological development on the one side.

On the other side, Chad in Africa owned in 2014 foreign exchange reserves of 1.08 billion dollars which is not high. Its nominal GDP per capita was no more than 1000 dollars in that year; this indicates that it is one of the poorest countries despite having oil and minerals in its national territories. (This is the case of some of the less developed countries whom we hope would progress and grow to have a better situation in the future).

Another case that proves that foreign currency reserves can be one indication of economic power (but of course not the only one) is that United Arab Emirates held about 85 billion dollars as foreign currency reserves. However, this country has a sovereign Wealth Fund of 792 billion dollars, most of which they accumulated from natural oil but they were successful at economic diversification such as industry, tourism ( especially Dubai ), commerce, real estate and other services. UAE has formed one of the largest sovereign wealth funds or investment funds in the world diversifying and managing their investments in many countries and sectors as a way of preserving their wealth for present and future generations to obtain economic security and financial return from such investments, which are much more advisable, safer and wiser than keeping all their wealth as foreign currency reserves at the central bank. Moreover, UAE has one of the highest average salaries and wages in the world. The list goes on and on about the amount of foreign exchange reserves or foreign currency reserves in relation to economic strength, development and flow of funds both to and from an individual country.

In Conclusion, foreign currency reserves constitute one sign of economic strength and prosperity especially when such reserves are well managed and protected from exchange rate fluctuations. Generally, but not in every single case, if a country has development in various and multiple economic sectors , its foreign currency reserves will grow gradually but it would be preferable if it invests some of its wealth in diversified and high quality portfolio of securities, treasury bonds of high ratings, blue chip equities, infrastructure projects , and productive sectors like agriculture and manufacturing.

   Refrences :

– Eljoumhouria newspaper

– internet sources