(a) It is the ratio of value of imports to the Gross Domestic Product of a country
(b) It is the total value of imports of a country in a year
(c) It is the ratio between the value of exports and that of imports between two countries
(d) It is the number of months of imports that could be paid for by a country’s international reserves
Answer: d
Explanation:
Foreign exchange (FX) reserves are an integral part of the policy toolkit as they insure against shocks and complement monetary policy to achieve price and financial stability. At the same time, building and holding FX reserves is not without costs. To fulfil their main purposes, FX reserves need to be invested in safe and liquid assets, where yields are low
FX reserve adequacy measures
There is no unique framework for assessing the adequacy of FX reserves for precautionary motives. Central banks follow an array of measures that compare a country’s FX reserve position with proxies for a specific risk or vulnerability. These measures provide a practical starting point, but a complete assessment must consider country-specific factors such as the exchange rate regime and capital account openness as well as financial market depth and liquidity. Traditional measures employed include:
Import cover: measures the number of months that FX reserves can sustain imports. This indicator is considered relevant for countries with a closed capital account. The benchmark is three months of coverage.
Ratio of FX reserves to short-term external debt: measures the potential demand for repayments related to a country’s short-term external foreign currency borrowing. The Guidotti-Greenspan rule proposes a 100% cover. This rule can be extended to consider the full potential 12-month financing need, measured by short-term external debt minus the current account balance.
Ratio of FX reserves to broad money (M2): measures the potential demand for foreign assets from domestic sources. This indicator is considered relevant for countries with financially developed markets and an open capital account. The benchmark is typically set at 20%.
Assessing FX reserve adequacy (ARA) metric: measures a broad set of risks reflecting potential drains on the balance of payments. The IMF’s metric has four weighted components: short-term external debt; M2; export income; and other liabilities. The last two components reflect potential terms-of-trade shocks and other portfolio outflows, respectively. The measure is adjusted if the country is dollarised, if it has capital controls or if it is a commodity exporter/importer. The benchmark is between 100% and 150% FX reserve cover.
Jeanne and Rancière (2011): measure the optimal level of FX reserves by calibrating a cost-benefit model. The model balances the opportunity cost of holding FX reserves with the gains from smoothing domestic absorption during sudden stops. The level of optimal FX reserves varies considerably depending on the assumptions on output loss, probability of a sudden stop, and risk aversion.