Short-Term External Debt and Fear of Losing International Reserves

Abstract

During the global financial crisis of 2008 and 2009, some emerging market economies abstained from using their international reserves and allowed their currencies to depreciate despite large international reserve holdings. Applying the difference in differences approach to the sample of 18 emerging market economies, we investigate the factors that contributed to fear of losing reserves. The result shows that while emerging market economies in general did not show fear of losing reserves during normal times, those with relatively high short term external debt compared to their international reserve holdings became reluctant to rely on using reserves during the global financial crisis period, implying that short term external debt was the key factor for the reluctance to use international reserves displayed by some emerging market economies. In this regard, countries with high short term external debt should adopt adequate measures such as establishing international financial safety nets and introducing capital flow management measures in addition to building up international reserves in order to maintain foreign exchange stability against sudden stops of capital flows.