Impact of economic growth on international reserve holdings in Brazil

This study investigated the impact of economic growth on Brazilian international reserves holdings in the context of Error Correction Mechanism using data over the 1980-2014 period. The results reveal that economic growth is highly significant. From the estimation of our model, we argue that economic growth and international reserves have positive long run relationship. Error correction estimates validated our model for error correction term is negative and statistically significant. Besides, our model suggested that economic growth has short run relationship too. The speed of adjustment is more than 40% which indicated that error correction term corrects previous year disequilibrium at the rate of 40.4%. KEYWoRDS: Brazil; Economic Growth; Error correction model; International reserves. JEL Classification: F41; F43; F62. Brazilian Journal of Political Economy, vol 37, no 3 (148), pp 605-614, July-September/2017 * Research Scholar, Department of International Business, School of Management, Pondicherry Central University, India. E-mail: mkashif69@gmail.com. , Associate Professor & Head, Department of International Business, School of Management, Pondicherry Central University, India. E-mail: psridharan@lakshmisiri.com, Assistant Professor, Department of International Business, School of Management, Pondicherry Central University, India. E-mail: thiyagarajan.ibm@pondiuni.edu. in 605 http://dx.doi. org/10.1590/0101-31572017v37n03a08 Revista de Economia Política 37 (3), 2017 • 606 Brazilian Journal of Political Economy 37 (3), 2017 • pp. 605-614 INTRoDUCTIoN International reserves or foreign exchange reserves are a country’s external assets that include gold, Special Drawing Rights (SDRs), foreign currency deposits and bonds held by central banks and monetary authorities. According to International Monetary Fund, international reserves are “Those external assets that are readily available to and controlled by the monetary authorities for meeting balance of payments financing needs, for intervention in exchange rate markets to affect the currency exchange rate, and for other related purposes” (IMF’s BPM6, 2014). The top ten holders of international reserves account for nearly two-thirds of the world’s total international reserves. China, with USD 3.86 trillion at the end of 2015, tops the list. Ten years ago it had only USD 822 billion. Second is Japan with USD 1.2 trillion (as on Jan’ 2016). The list is going on but Brazil comes on eighth position with USD 358,799 million as of Jan’ 2016. There is an increasing debate about the need to have large stocks of foreign exchange reserves. Research on international reserves was started during 1960s particularly when Heller (1966) presented the estimations of the optimum level of international reserves by comparing marginal cost to marginal benefit. Balassa, B. (1977) employed Brazil as one of the countries in his sample and found that exports growth favorably influences the rate of economic growth over the contributions of domestic and foreign capital. Mendoza, R. (2004) considers that reserve management in emerging countries is motivated by precautionary purposes against financial crises. Chin-Hong et al. (2011) found a positive relationship between economic growth and international reserves in case of Malaysia. The same results are derived by Irefin and Yabaa (2012) for Nigerian economy. Gonzaga, F. (2003) applied Thirlwall’s BoP model to economic growth in Brazil and found that the external constraints affect strongly the pattern of economic growth. Malloy, M. (2013); ostry et al. (2011) investigate that a number of factors may affect the foreign exchange reserves, they presented three main determinants-first, to smooth short run fluctuations of exchange rate; second, reserves are accumulated for precautionary and third for competitive motives. Feder, G. (1982) suggested that economic growth based on foreign trade and external sector policies is reasonable as these policies take the economy close to optimal allocation of resources. Bacha, E. (1977) stated that foreign capital had a persistent and dynamic role in economic growth in Brazil. The amount of global international reserves is one of the highest in history. Additionally, the reserve holdings pattern has been increasing at a faster pace since early 1990s. Figure 1 shows the reserve volumes over the 1980-2014 sample period for Brazil. It clearly illustrates that Brazil accumulating international reserves at a fast pace. It also shows that the amount of international reserves continuously increasing since 1990.