Beyond Liquidity: New Uses for Developing Asia's Foreign Exchange Reserves

Developing Asia's foreign exchange reserves have grown explosively since 2000. Evidence indicates that a substantial part of the region's reserves are now surplus to what is required for traditional liquidity purposes. There is consequently a growing consensus for managing such surplus reserves more actively. The notion that surplus reserves should be used to pursue higher returns is not only politically popular but economically sound. Nevertheless, it is critical to note that developing Asia's reserves are not free fiscal assets. Unlike the reserves themselves, the income from investing those reserves does represent a fiscal dividend for the government. This and other factors suggest that the first-best use of developing Asia's surplus reserves is to invest them abroad with the goal of maximizing risk-adjusted returns, subject to the government's broad guidance. The resulting expansion of fiscal space will help the region's governments tackle the huge long-term developmental challenges still facing the region.