Managing international reserves: how does diversification affect financial costs?

As reserve accumulation has gathered pace in recent years, and as foreign exchange (FX) reserve holdings have risen far above conventional measures of reserve adequacy, a vigorous debate has begun as to whether part of the reserves should be invested in riskier assets to reduce their financial costs. Estimates from hypothetical reserve portfolios of selected emerging market economies over the period 1999-2007 suggest that the reduction in financial costs from holding riskier assets would generally have been small relative to GDP. Accounting practices and profit distribution rules are likely to play an influential role in asset allocation decisions.

JEL classification: G11, G18, G28.