What is a Foreign Reserve? | And Why do I Need It?

What is a Foreign Reserve?

Affiliate Disclaimer: This post may contain affiliate link or links

What is a foreign reserve? A foreign reserve is a controlled amount of assets, typically gold, held in a central bank. As an example, the United States has gold reserves of eight thousand eight hundred and sixty-five metric tons as of 2010, this represents 75% of their reserves.

As of 2011 China, France and Russia have the highest holdings as three largest foreign reserves as a portion of GDP. A foreign reserve (also known as FX reserve) is a component of a country’s foreign exchange reserves.

It usually includes the foreign exchange reserves held by the Bank of the Central Bank of the particular country, but essentially can comprise of other government organizations and other state institutions that are designated to hold foreign exchange.

When referring to foreign currency, a reserve is a currency that a country prevents from entering its own economy. In other words, it’s a measurement of how many units of a certain currency are held by foreign institutions that aren’t distributed across their economy. In other words:

The percentage of their own currency that sits in foreign hands. While most governments now hold reserves on their own currencies (also known as RMB or CNH), sometime the term can also apply to monetary system reserves such as gold, or even precious metals for protecting economies against inflation values.

8 Tips to understanding foreign reserves

  • What is a foreign reserve?
  • How do foreign reserves work?
  • Which country has most foreign reserves?
  • Important of foreign reserves
  • Purpose of foreign reserves
  • Foreign reserves by country
  • What happens when a country runs out of foreign reserves?
  • Where is nigeria foreign reserve kept
What is a Foreign Reserve

What is a foreign reserve?

A foreign reserve is a central bank’s holdings of foreign currencies, typically in the form of government bonds. Foreign reserves are held by central banks to stabilize the value of their own currency and to prevent balance of payment crises.

A country’s foreign reserve is generally inversely related to its current account deficit. A country with a trade deficit may need to borrow money from abroad.

For example, if it imports more goods than it exports, its current account deficit will be greater than its capital account surplus (which includes inflows from foreign direct investment).

In order to pay for the difference between imports and exports, the country must borrow money from foreigners or sell off some of its assets.

The country’s central bank might also purchase foreign bonds to maintain a relatively stable exchange rate against other countries’ currencies. The amount of foreign reserves held by a country depends on how much trade it does with other countries.

If a country is heavily dependent on trade with other countries, it will likely hold large amounts of foreign reserves since it will be required to maintain enough liquidity to meet short-term debt obligations that arise due to trade imbalances or other factors.

Read more article: Forex Courses for Beginners

What is a Foreign Reserve

How do foreign reserves work?

Foreign reserves are the foreign exchange holdings of a country. They include all the foreign currency deposits held by a country’s central bank and commercial banks.

The purpose of holding reserves is to support the value of a country’s currency, as well as to fulfill other functions such as supporting international trade, providing liquidity, and acting as a safeguard against balance of payments crises.

Foreign reserves are often used by central banks and governments to intervene in the market place in order to influence exchange rates and interest rates. By doing so they can affect the supply and demand for their domestic currency in order to control its value relative to other currencies.

For example, if there is an increase in demand for Australian dollars from overseas then this will lead to an increase in demand for Australian bonds (an increase in supply). This would normally cause bond prices to fall and interest rates would rise.

The Reserve Bank of Australia (RBA) would then buy back some of these bonds by selling Australian dollars off its foreign exchange reserves, thereby reducing supply and thus lowering the price of Aussie bonds (increasing demand) and lowering interest rates back down again.

A country’s foreign reserves are the amounts of foreign currencies and gold it holds in reserve for use in international trade and financial transactions. These reserves may be held in a variety of assets, including Treasury securities, deposits with foreign central banks and U.S. Agency debt securities.

A country’s central bank will generally hold its foreign exchange reserves as part of the country’s monetary policy to control inflation, maintain stable prices and manage the supply of money.

When a central bank buys foreign currency, it increases its own money supply while lowering the supply of foreign currency available elsewhere in the market. Similarly, when it sells foreign currency, it reduces its own money supply while increasing the supply of foreign currency elsewhere.

Read more article: Tax Free Countries for Forex Trading

What is a Foreign Reserve

Which country has most foreign reserves?

The United States is the world’s largest economy, but it has a smaller reserve of foreign currency than some of its neighbors. As of December 2018, China held more than $3 trillion in foreign reserves, according to the World Bank.

Japan’s central bank had $1.05 trillion and the European Central Bank had €512 billion ($583 billion) in foreign reserves. The U.S. Treasury Department reported that as of March 2019, the United States held $112 billion in gold and silver as part of its foreign exchange reserves.

The World Gold Council reported that as of January 2019, the United States held 8,133 tons of gold and silver as part of its foreign exchange reserves or about 23% of its total holdings which totaled $23 billion at the time.

China also have the most foreign exchange reserves in the world. The country’s reserves were valued at $3.1 trillion as of March 2018, with Japan coming in second with $1.1 trillion.

China has been buying up U.S. Treasuries and other assets to protect its currency, the yuan, from weakening too much against the dollar. The country is also trying to insulate itself from any potential trade war or economic fallout from U.S.-China relations, according to Reuters and CNBC.

Many experts have been concerned about China’s growing debt burden and impact on global financial markets. However, China’s foreign reserves have fallen by about $400 billion since the beginning of 2018 due to a combination of capital outflows and efforts to stabilize its currency by buying dollars, according to Reuters and CNBC.

Read more article: Open Demo Account for Forex Trading

What is a Foreign Reserve

Important of foreign reserves

The foreign reserves of a country are the amount of foreign currencies held by the Central Bank or other monetary authority. These reserves usually consist of US Dollars, Euros and Japanese Yen.

The reserves are used to stabilize the value of domestic currency by controlling its supply and demand, which in turn helps to maintain the value of foreign currency.

When there is excess supply of domestic currency in the market, the Central Bank will buy them from private banks at a higher rate than their face value. This increases the demand for foreign currency and reduces its supply.

This process helps to reduce inflationary pressures by increasing foreign exchange earnings from exports and decreasing imports.

In case there is excess demand for domestic price of domestic currency increases due to this excess demand, thus making it expensive for importers to buy goods from abroad.

As a result they will be less interested in buying imports, thus reducing their demand for foreign currency. This again reduces inflationary pressures by decreasing foreign exchange earnings from exports and increasing imports.

Reserves are used as one means of ensuring a country’s ability to import goods and services and to protect against financial crisis. They are also used to intervene in foreign exchange markets to maintain the value of a currency at a desired level.

They have different names around the world. In some countries they are called official reserves or foreign exchange reserves; in others they are referred to as international reserves, foreign currency reserves or even hard currency reserves.

Read more article: Practice Account for Forex Trading

What is a Foreign Reserve

Purpose of foreign reserves

The main purpose of foreign reserves is to provide a country with the ability to maintain its balance of payments. This means that if a country imports more than it exports, it will need foreign reserves to cover the difference.

If a country does not have enough foreign reserves, then it will be unable to pay for these imports and may default on its loans. This can lead to an economic crisis. In order to avoid this, countries will often hold large amounts of currency in reserve as an insurance policy against potential problems.

Foreign reserves are the foreign currencies held by a central bank or government. They can be used to pay off foreign loans and obligations, or they can be used as a form of international aid.

If a country has high levels of debt and has difficulty paying it back, it may have to use its reserves to pay off creditors. A country’s foreign reserves are usually denominated in U.S. dollars because most international transactions take place in that currency.

A country that has strong economic growth and low inflation may have an excess amount of foreign currency these countries can often purchase assets from other nations with their excess dollars.

When a country has weak economic growth, it may need to sell some of its assets in order to pay off debts and avoid defaulting on its loans. The sale of these assets is known as “monetizing” the currency essentially creating new money out of thin air.

This can cause inflation if not done properly; for example, if too many dollars were created without any goods backing them up, prices would rise dramatically as more dollars were available for goods than goods were available for dollars

What is a Foreign Reserve

Foreign reserves by country

Foreign reserves are the foreign assets held or controlled by a central bank or monetary authority of a country. The reserves are made up of gold or a specific currency, usually US Dollars. Here is a list of top countries with highest foreign reserves.

Top 10 Countries with Highest Foreign Reserves in 2019

1. China: $3 trillion – China is the world’s largest holder of foreign exchange reserves and they have been growing at an impressive rate since 2000. China’s foreign exchange reserves are invested in U.S. Treasuries, agency securities, corporate bonds and equities.

2. Japan: $2.2 trillion – Japan’s foreign exchange reserves are managed by the Ministry of Finance (MOF) and Fiscal Investment and Loan Plan (FILP). The MOF invests about 80% of its portfolio in Japanese government securities (JGS), while FILP invests about 20% in riskier assets such as stocks and bonds issued by private corporations and foreign governments/central banks.

3. Eurozone: $2 trillion – The Eurozone consists of 19 countries that use the euro currency: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland.

Read more article: Basics of Forex Trading for Beginners

What is a Foreign Reserve

What happens when a country runs out of foreign reserves?

When a country runs out of foreign reserves, it is no longer able to pay for imports. This can mean that goods become scarce, or even impossible to find. It can also mean that the government has to come up with creative ways to keep the economy going.

You’ll hear about countries running out of foreign reserves when there are political problems or economic crises in those countries. For example:

The Soviet Union ran out of foreign reserves in 1991 as it collapsed and a new Russia emerged this led to widespread poverty and starvation amongst its citizens

In 1998, when Russia defaulted on its debt, it ran out of foreign reserves – leading to political upheaval and social unrest

In 2007/2008 as China was hit by an economic crisis, its demand for raw materials dropped off dramatically causing many countries that export raw materials to lose their main trading partner.

In the case of an emergency, like an unexpected drop in exports or an increase in imports, foreign exchange reserves can be used to pay off debts and buy time until the economy recovers.

However, if there is no one willing to lend money to your country and its economy is not going well, you may have to sell your reserves at a discount. This will cause further damage to your economy and make it harder for you to pay back your debtors.

If you’re unable to repay your debts fully or on time due to a lack of foreign exchange reserves, lenders will start selling your bonds and demand higher interest rates for those that remain outstanding.

That means more money has to be spent servicing these debts instead of being invested elsewhere in the economy (for example, on infrastructure).

Read more article: Free Software for Forex Trading

What is a Foreign Reserve

Where is Nigeria foreign reserve kept

Nigeria’s foreign reserves are kept in different countries where the Central Bank of Nigeria has a branch. It is usually kept in US dollars and British pounds, but other currencies can be used as well.

The CBN has two main branches in London and New York City. The London branch is called “CBN London Branch” while the New York City branch is called “CBN (New York) Branch”.

These two branches hold most of Nigeria’s foreign reserves. Other CBN branches around the world also hold some of Nigeria’s foreign reserves as well.

More also, Nigeria’s foreign reserve is kept in a special vault at the Central Bank of Nigeria (CBN). The CBN has two depositories, one in Abuja and the other in Lagos. The Abuja vault was constructed in 1975 while the Lagos vault was built in 1992.

The CBN’s foreign reserves are valued in dollars and euros, mostly allocated to its foreign exchange operations. The reserves are also used to stabilize the naira against other currencies as well as offer protection against external shocks that could negatively impact Nigeria’s economy.

The Naira has depreciated against the dollar by 9 percent since the beginning of 2019 amid rising inflation and a slowdown in growth.

According to data from the Central Bank of Nigeria, the nation’s foreign exchange reserves stood at $45.5 billion as at December 31, 2019. This is a fall from $46.2 billion as at October 31, 2019, but an increase from $44.8 billion as at September 30, 2019 and $43.6 billion as at August 31, 2019.

What is a Foreign Reserve

Final thought

In simple terms, a foreign reserve is the (usually) gold or foreign currency that a country keeps on hand as a store of value and in case of economic instability. They are typically held in large quantities almost as an investment.

If you take a look at the chart below, you’ll see that the United States has maintained the highest level of foreign reserves for over two decades:

Inflation refers to the general increase in price level of goods and services in an economy. It is important because it leads to a decline in the purchasing power of money, thereby reducing a person’s financial ability to buy goods or services.

A foreign exchange reserve is an amount of hard currency held by a central bank or monetary authority. It allows the country to earn interest on its holdings, and also uses that money for emergency funds in case of any external economic emergencies.

The “reserve” in this case refers to the excess kept at the central bank. This excess is used to cover those future payments that are expected to occur.

These include, first of all, whatever is left of the previous account balance. It also includes international transactions made by the country and its political subdivision that have not been settled yet.

Read more article: Get Funding for Forex Trading

Want to learn how to trade forex? Click here!

Other related articles

Leave a Reply

Your email address will not be published. Required fields are marked *

Latest posts