INTERNATIONAL

LIQUIDITY AND RESERVES

PROBLEMS

Presented by
Abhishek Singh-R590210002
Amber Chourasia-R590210003
Lalita Khaklary-R590210012
Naman Gutpa-R590210016
Uthamaveeran S-R590210021
Varun Kumar -R590210022
 AGENDA

08/10/11 International Liqutity and Reserves problems



 What is international liquidity

 History of international liquidity

 Constituents of international liquidity

 Problems of international liquidity

 Policy guidelines to overcome the issues

 Conclusion

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INTERNATIONAL LIQUIDITY

08/10/11 International Liqutity and Reserves problems

Ø
Ø International liquidity means the relative
amount of resources available to a nation’s
monetary authorities that could be used to
settle a balance of payments deficit.
Ø
Ø
Ø International liquidity includes international
borrowings, commercial credit operations
and the international financial structure in a
country’s reserves.
 3

Ø
History of International liquidity

08/10/11 International Liqutity and Reserves problems

 In the days of the gold standard, this
would mean access to gold that could
be used to redeem a nation’s currency
held by foreigners

 Before Bretton Woods agreement till
1960 the exchange rates of countries
were fixed in terms of gold or the US
dollar at $35 per ounce of gold

4



Contd…

08/10/11 International Liqutity and Reserves problems

 After 1971, with the abandonment of the
dollar-gold exchange standard, as the world
entered an era of ‘managed’ exchange
rates, some ‘floating’, some ‘pegged’,
‘international liquidity’ came to mean the
resources available to national monetary
authorities to maintain the value of their
currencies as required by their exchange
management programs.


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 INTERNATIONAL MONETARY
RESERVES

08/10/11 International Liqutity and Reserves problems



§ International liquidity under the ownership

of the central bank
 Foreign exchange reserves in central
banks
 Unused Gold tranche at IMF
 Credit tranche
 Special drawing rights (SDR)


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INTERNATIONAL LIQUIDITY
FACILITATION

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§ International liquidity under the
ownership of all other agents in the
economy:-
 operative foreign exchange reserves

of commercial banks
 foreign exchange assets of non-

banking subjects abroad

 short-term foreign assets of the

residents
 long-term foreign bonds of the

residents
 possibilities of the banks to get 7

credits for financing balance-of-

CONSTITUENTS OF
INTERNATIONAL LIQUIDITY

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

 Primary Liquidity


 Subsidiary Liquidity


 Ad hoc Liquidity


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PRIMARY LIQUIDITY

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

 The primary medium of international liquidity

comprises of gold and foreign currencies
that are easily convertible and universally
acceptable
 Eg.- US dollar and Pound sterling.

 Therefore the amount of resource of gold , US

dollar and Pound the country holds
determines the primary international
liquidity of that country

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SUBSIDIARY LIQUIDITY

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 The Subsidiary liquidity is provided by the
International monetary fund to its member-
countries for the purpose of meeting current
balance of payments difficulties.
 A member country’s access to international
liquidity through the IMF falls into two parts-:
 The Gold tranche
 The Credit tranche
 The amount of liquidity received in credit from
IMF depends on the subscription quota
 Gold tranche:25% of quota
 Credit tranche:25% of quota
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
ADHOC LIQUIDITY

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 The ad-hoc supply of international liquidity
comes through currency arrangements
arrived at bilaterally.
 The countries that fulfill the obligations of
article viii of IMF comes under this kind
 There are 10 countries: Belgium, Canada,
France ,western Germany, Italy, Japan,
Netherlands, Sweden ,UK, USA and
Switzerland.
 It acts as a first line of defense due to
currency weakness due to short term cash
outflow 11
08/10/11 International Liqutity and Reserves problems
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RESERVE PROBLEMS
Reserves problems

08/10/11 International Liqutity and Reserves problems

 Rapid reserves growth
 Exchange rate volatility

 Systemic imperfections

 Potential sources of instability

 Volatile capital flows

 Ratchet effects

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Rapid reserves growth

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 Forecast potential reserve growth.


 To meet the future need of the country.



 Levels of Assessment

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Exchange rate volatility

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 External credibility problems


 High and low exchange rate



 Difficulty in handling interest rate for

countries.


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Potential Source of Instability

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 two possible threats to IMS stability arise from
reserve accumulation that is large relative to
the size of the reserve issuers
 QualitativeEffects
 Quantitative Effects

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Volatile capital flows

08/10/11 International Liqutity and Reserves problems

 A feature of globalization has been huge
growth in private international financial
flows
 The volume of global net private capital flows
going to emerging markets increased
sharply—from $90 billion in 2002 to $600
billion in 2007.
 This growth, which has generally been seen as
welfare enhancing, is expected to continue.
 However, many emerging markets have very
small financial intermediation capacity
compared to the large inflows they can 17
attract.

Ratchet effects

08/10/11 International Liqutity and Reserves problems

 In addition to self-insurance, and to the extent
international investors consider high
reserves indicative of lower risk for them


 Individual countries may feel compelled to

acquire reserves not only sufficient to cover
their own needs in a “sudden stop”



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Constituents of International
liquidity

08/10/11 International Liqutity and Reserves problems

 Primary liquidity: Gold and those foreign
currencies which are universally accepted.
 Subsidiary Liquidity: provided by IMF to its
member countries for meeting current
balance of payments difficulties.
 Ad Hoc liquidity: supply of international
liquidity to the participating countries in
need of liquidity

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Inadequacy of International
liquidity

08/10/11 International Liqutity and Reserves problems

 Developed countries: There is no problem of
international liquidity
 Developing countries: Increased provision of
International finance through foreign aid
helps pushing the rate of economic growth.
These countries generally face a chronic
shortage of international liquidity.

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Policy Guidelines

08/10/11 International Liqutity and Reserves problems

 In order to overcome the shortage of
International liquidity:
 Transfer the primary resources of international
liquidity from rich countries to poor
countries.
 G.A.T.T and I.B.R.D two U.N agencies are
looking into it.

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SOLVING INTERNATIONAL
LIQUIDITY PROBLEMS
 BALANCE OF PAYMENT
ADJUSTMENT

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 Long-run equilibrium in the current account.
 Neoclassical view and realistic circumstances
in the world economy:
 validity of the automatic elimination of
the balance-of-payments disequilibria
assumption
 analysis of the balance-of-payments
disequilibrium emergence
 difference in different groups of economic
agents


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 CONSISTENCY OF THE SYSTEM AND
CONFIDENCE

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
 Relevance of the mechanism for the elimination
of balance-of-payments disequilibria
 appropriateness of the size of the international
liquidity
 establishment of a mechanism for the
coordination of the balance-of-payments goals


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MECHANISMS FOR ESTABLISHING A CONSISTENT
INTERNATIONAL MONETARY SYSTEM

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

 Automatic adjustment mechanism

 N-1 system

 International coordination system

 Monetary union system

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 AUTOMATIC ADJUSTMENT MECHANISM

08/10/11 International Liqutity and Reserves problems

 changing the level of foreign exchange supply and
demand:
 flexible exchange rate:


de fic it

do me stic  c urre nc y de pre c iatio n

↓ ∆ fo r & ↑Σ o f fo re ign 

exc hang e

balanc e ­o f­payme nts e quilibrium

26
 AUTOMATIC ADJUSTMENT MECHANISM

08/10/11 International Liqutity and Reserves problems

 fixed exchange rate:
 through price changes
 through changes in aggregate expenditures


Marginal 
propensity to 
import
Decreased 
imports
Multiplier
Fall in  Decrease in  Decrease in
aggregate  GDP domestic demand
expenditure
s Increased exports

Balance­of­ Decrease in 
payments  Fall in  the deficit
deficit supply of 
money
Decreased 
Improved 
Lower rate  imports
competitiveness  Price elasticities
of inflation relative to other 
countries 
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Increased exports
 N-1 SYSTEM

08/10/11 International Liqutity and Reserves problems

 n-th country currency (N-currency) is
convertible into a widely accepted good at a
fixed price, the currencies of all other
countries are related to it in a fixed
relationship
 countries must accept and implement
economic policy measures for balance-of-
payments adjustments

rie s with a surplus are  unde r signific antly lo we r pre ssure  to  adjust the ir b

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ASYMMETRY OF ADJUSTMENT

08/10/11 International Liqutity and Reserves problems

 countries with a balance-of-payments deficit
carry a relatively higher cost burden
 N-country must accept whatever net balance-
of-payments position is dictated by the
group of n-1 countries in the system:
 strong and a fairly closed economy at the same
time
 N-currency must be stable


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 INTERNATIONAL COORDINATION
SYSTEM

08/10/11 International Liqutity and Reserves problems

 economic policy coordination of the world
economic forces & exchange rate movement
coordination
 crucial: exchange rate regime choice
 reasons for balance-of-payments
disequilibrium:
 external shocks
 weak or no accordance in the economic
policy of individual countries


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 MONETARY UNION

08/10/11 International Liqutity and Reserves problems

 countriescompletely give up their national
monetary policy and surrender it to some
above-national institution






 common currency becomes the only legal
tender in all monetary union member
countries
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
Bottom Line

08/10/11 International Liqutity and Reserves problems

 Problems are not unavoidable as per IMS
 There is no clear market-driven process that
would bring about a more robust system.
 The Fund can play a role in making the system
more stable over the next decades

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 REFERENCES

08/10/11 International Liqutity and Reserves problems

 www.imf.org
 www.meaindia.nic.in

 www.wikipedia.org

 www.scribd.com

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THANK YOU