The motivation for foreign exchange reserves accumulation: Empirical evidence from developing countries

Abstract

Using two-way fixed effects estimation with data from 77 developing countries for the period 2000- 2022, the article provides evidence that foreign exchange reserve accumulation comes from both motives: mercantilism and insurance, in which the insurance motive has the greater influence. The exchange rate regime and the level of financial openness are two factors that change the level of influence of accumulative motives of foreign reserves. The impact of exchange rates on foreign exchange can be in opposite directions among different exchange rate regimes. Countries with high financial openness are often more concerned with the internal liquidity reserve motive, on the contrary, countries with low financial openness are more likely to accumulate reserves for mercantilism. The research results provide an important policy implication for developing countries, including Vietnam, on the need to calculate and maintain the optimal scale of foreign reserve to ensure multiple management goal, and at the same time consider the characteristics of the exchange rate regime and the openness of the capital account of the economy itself.