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Working Paper 178 - Holding Excess Foreign Reserves Versus Infrastructure Finance: What should Africa do?

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    Financing infrastructure needs in Africa necessitates new thinking on financing mechanisms. This paper is a contribution to the debate on the use of excess foreign exchange reserves from different African countries as one of the funding sources for financing infrastructure. The study has: (i) extracted data on the foreign exchange reserve, debt and infrastructure needs of African countries from different IMF, World Bank and AfDB databases; (ii) estimated the adequacy level of foreign reserve for these countries based on two commonly used methodologies – the traditional metric method of import cover and the Wijnholds and Kapteyn (WK) method; (iii) then estimated the excess foreign reserve and the social cost of holding this excess based on comparison to other alternative investment opportunities such as investments in African infrastructure. Based on these estimations, the study has shown that: (i) African countries have held excess reserves in the range of $ 165.5 and $ 193.6 billion on average per year between 2000 and 2011. This is more than the infrastructure financing gap identified at $ 93 billion per year; and (ii) the social cost of holding these excess reserves amount to up to 1.65% in GDP terms on average. In addition, the study provides some suggestions on how central banks can innovate in their reserves management. A close collaboration between the central banks and the debt management offices on the alignment of foreign reserves and foreign debt is deemed crucial.

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    Paper provided by African Development Bank in its series Working Paper Series with number 478.

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    Date of creation: 24 Jul 2013
    Date of revision:
    Handle: RePEc:adb:adbwps:478
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    1. Frenkel, Jacob A. & Razin, Assaf, 1980. "Stochastic prices and tests of efficiency of foreign exchange markets," Economics Letters, Elsevier, vol. 6(2), pages 165-170.
    2. Bhattacharyay, Biswa, 2010. "Financing Asia’s Infrastructure: Modes of Development and Integration of Asian Financial Markets," ADBI Working Papers 229, Asian Development Bank Institute.
    3. Javier Bianchi & Juan Carlos Hatchondo, 2013. "International reserves and rollover risk," Globalization and Monetary Policy Institute Working Paper 151, Federal Reserve Bank of Dallas.
    4. Frenkel, Jacob A & Mussa, Michael L, 1980. "The Efficiency of Foreign Exchange Markets and Measures of Turbulence," American Economic Review, American Economic Association, vol. 70(2), pages 374-81, May.
    5. Robert P. Flood & Nancy P. Marion, 2002. "Holding International Reserves in an Era of High Capital Mobility," IMF Working Papers 02/62, International Monetary Fund.
    6. Graham Bird & Ramkishen Rajan, 2003. "Too Much of a Good Thing? The Adequacy of International Reserves in the Aftermath of Crises," The World Economy, Wiley Blackwell, vol. 26(6), pages 873-891, 06.
    7. Mendoza, Ronald U., 2004. "International reserve-holding in the developing world: self insurance in a crisis-prone era?," Emerging Markets Review, Elsevier, vol. 5(1), pages 61-82, March.
    8. Frenkel, Jacob A, 1974. "The Demand for International Reserves by Developed and Less-Developed Countries," Economica, London School of Economics and Political Science, vol. 41(161), pages 14-24, February.
    9. Jacob A. Frenkel & Michael L. Mussa, 1980. "Efficiency of Foreign Exchange Markets and Measures of Turbulence," NBER Working Papers 0476, National Bureau of Economic Research, Inc.
    10. Léonce Ndikumana & Adam Elhiraika, 2007. "Reserves Accumulation in African Countries: Sources, Motivations, and Effects," UMASS Amherst Economics Working Papers 2007-12, University of Massachusetts Amherst, Department of Economics.
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