The appropriate level of international reserves: functions, vulnerabilities and strategies for their reconstruction

Determining the appropriate level of foreign reserves has been a central question of economic policy since the middle of the 20th century. In the postwar period, when capital controls were widespread and fixed exchange rates prevailed, reserves were valued by the number of months of imports. With financial liberalization, the opening of capital accounts, and greater vulnerability to external shocks, these metrics became inadequate and analysis began to consider the relationship between reserves, short-term debt, monetary aggregates, and fiscal and financial vulnerabilities.

Above these contingent measures, reserves fulfill two conceptually different functions: they are a macroeconomic self-insurance mechanism and at the same time an operational instrument of monetary and exchange rate policy. Using this distinction, it is possible to order the relevant criteria, to assess the Argentine situation – characterized by an exceptionally low level of reserves – and to analyze how it can be restored without generating inflationary tensions.

At their deepest dimension, reserves act as an insurance policy, allowing countries to absorb fiscal, financial and real shocks. Its need depends on structural factors.

The first is the financial situation. Keynes pointed this out in his Treatise on monetary reform that countries with persistent deficits need to maintain higher reserve levels because they rely on financing that is subject to abrupt interruptions. Countries with budget surpluses, on the other hand, can get by with smaller buffers without endangering their stability.

The second factor is access to international credit markets. When this access is broad and stable, reserves act as a supplement; When restricted, they become the only source of immediate liquidity. In the euro area, for example, the existence of a supranational lender of last resort reduces the need for its own reserves.

Connections to multilateral organizations are also important. The conditional credit lines of the IMF they act as a partial replacement for reserves: if they are available, the need for provisions decreases; If they have been used intensively, there is an obligation to rebuild reserves to restore autonomy.

The production structure is another determining factor. Countries with high dependence on primary exports face significant fluctuations in their terms of trade and require a larger buffer. This also applies to economies that depend on flat local financial markets or coexist with large economic neighbors whose policies have effects that are difficult to predict.

Finally, the degree of trade openness determines the ability of the real exchange rate to absorb shocks. More open economies adapt more quickly and require fewer reserves; In closed countries, where actual adjustment is slower and more costly, reserves play a crucial stabilizing role.

Reserves also perform an instrumental function related to the day-to-day functioning of economic policy. This is not only about protection against external shocks, but also about the operational ability to maintain the exchange rate system and financial stability.

The first determinant is the exchange rate regime. With a clean float, the need for reserves is relatively low; A significantly higher level is required in managed floating systems or when the monetary authority wants to smooth out large fluctuations in exchange rates.

Opening the capital account also increases the need for reserves, especially during normalization or liberalization processes when initial capital flows can be large and volatile.

Finally, in bimonetary economies – such as Argentina, Peru either Uruguay— If a relevant part of the deposits is denominated in dollars, the reserves support the reserves in foreign currency and enable the exercise of the role of lender of last resort. This feature significantly increases the operating reserve requirement.

Given these criteria, the situation in Argentina is extremely fragile. Net reserves and even gross liquidity are systematically below the minimum thresholds of all relevant international measures: they do not cover short-term debt, they do not adequately support the monetary base and they do not enable an orderly transition to a more normalized exchange rate system.

In addition, the country faces an additional structural constraint: Argentina’s private sector is a net creditor to the rest of the world. The ability to build reserves depends almost entirely on the public sector. If it absorbs private savings through persistent deficits, exchange controls or financial repression, that will Central Bank remains without the possibility of restoring its external balance.

The result is a country without macroeconomic protection and with weakened operating margins, which explains the recurrence of episodes of exchange rate volatility and balance of payments crises.

In the Argentina Currently, the key question is not just how much to accumulate, but also how to do so without increasing inflation or exacerbating the fragility of the public balance – issues highlighted by the president Milei and his economic team repeated. Conceptually, there are three basic mechanisms.

If the public sector reduces the absorption of private savings or, better yet, generates a budget surplus, the Central Bank can buy foreign exchange without expanding the monetary base. This mechanism simultaneously improves the solvency of the government and the liquidity of the central bank. It is the path taken by most successful stabilizations at the international level.

A second option is to accumulate reserves through debt – external, internal, multilateral or bilateral – and use these funds to acquire foreign currencies. This method allows for a rapid recomposition of reserves and without direct inflationary effects, but its sustainability depends on the structure of the liabilities that finance these international assets.

The quality of a provision depends on the quality of the underlying liability. Reserves financed with short-term debt are more vulnerable than those financed with long-term debt. Likewise, reserves funded by foreign currency liabilities are riskier than those funded in local currency because they represent a future liability for the same asset you are trying to accumulate. Likewise, speculative capital flows (“hot money“) can reverse abruptly, unlike foreign direct investment, which is not only more stable but often also contributes to the creation of future export capacity.

The experiences of comparable countries are exemplary. Peru Thanks to a combination of stable capital flows, privatization and multilateral financing, the country accumulated significant reserves in the 1990s, even against a backdrop of significant current account deficits. Uruguayalso with a bimonetary economy, managed to build a robust cushion through more mature debt and prudence in liability management.

So debt can be an effective tool for rebuilding reserves, but its sustainability depends on the maturity, the currency and the stability of the flows that finance it.

A third option is to convert public sector assets – equity investments, real estate, concessions, future royalties – into liquid international assets. This operation does not generate inflation and improves the liquidity of the Central Bankalthough it has an impact on state assets. This can be valuable during transition periods or in programs that require rapid accumulation of reserves to stabilize expectations.

The appropriate level of international reserves is not determined by a hard and fast rule, but by the interaction of structural vulnerabilities and operational needs. In the Argentina Both dimensions currently converge in a clear diagnosis: Reserves are not sufficient to stabilize the present and protect against future shocks.

In order to rebuild a sufficient population, a distinction must be made between temporary mechanisms and permanent solutions. Liquidity can initially be provided through debt and asset conversion, but only sustained public savings efforts make it possible to build up long-term reserves while strengthening the state’s solvency and the stability of the economy. Central Bank.

In short, international reserves reflect the financial health of the public sector. When the government saves, reserves grow; If it absorbs private savings or is financed inefficiently, reserves will be depleted. Argentina’s future stability will depend on the eventual development.

López Murphy is a Professor of Economics and former Minister of Economy and Defense and former National MP, and Dell’Aquila Smith has a degree in International Relations