The official reserve account is a term used to denote the account where all sorts of reserves are held by the monetary authorities or the central banks of various countries. Or we can say the total reserves held by the authority/central bank. Through these reserves, the central bank or the government of the country attempts to balance international payments annually. Hence, sometimes it is also referred to and linked to Balance of Payments (BOP). If a country experiences a trade surplus in a year, then the balance in the official reserve account rises. And, in case of a deficit, the balance of the account goes down. The government or the country’s central bank also uses this account to hold the foreign currency and other securities of the government. These securities could be bonds, gold, special drawing rights, etc. This account is a sub-division or part of the capital account.
Importance of Official Reserve Account
The following points will help to bring out the importance of the official reserve account:
- This account holds, stores, and shows the foreign currency and other securities of the government.
- The central bank uses it to balance the BOP in case of a deficit.
- The central bank may also use this account to change the exchange rate to support government policies. However, most central banks rarely influence the exchange rates or intervene for a very short time. Mostly, the banks leave it to the market factors to establish the exchange rate.
Relation with Balance of Payments
As said above, the official reserve account is linked to and is a part of the balance of payments. So, it is vital to know about the balance of payments and its other components.
A balance of payments is an account that shows the summary of all the receipts and payments a country has with other countries in a year. Basically, it shows a country’s trade performance (import and export), the foreign investment that a company gets, the country’s foreign exchange reserves, and more.
Components of Balance of Payments
The Capital Account records all the capital transfers, as well as any purchase and sale of real and intangible assets by a country. And all these capital transfers do not affect the income, production, and savings of the country. There are very few rare transactions that happen in the capital account. Therefore, the capital account usually remains the smallest part of a BOP.
On the other hand, the current account records all the trade transactions and shows the trading strength of the country. The transactions include the import and export of goods and services. It also measures the international transfers of capital, both private and official. When the activities of the people of the country provide enough income and savings to take care of all their purchase requirements, business activity, and infra funding, then the current account tends to be in balance. Therefore, whenever the income and savings are not enough to support the imports and other spending, there is a current account deficit.
This account shows the monetary movements into and out of the country. And it includes all the transfer of financial capital and direct investments. In other words, it measures the changes in asset ownership – domestic as well as foreign. Whenever there is an increase in foreign ownership of domestic assets, this account will have a surplus and vice versa. Effectively it would mean that the country is selling its assets to foreigners. However, in case of a deficit in this account, it would mean that the country has possession of foreign assets and thus purchasing those assets.
In the case of net capital inflows (or surplus in the capital account), the balance in the official reserve account would rise. And, in case of net capital outflows (or deficits in the capital account), the balance of the official reserves will go down.
Moreover, a surplus in the current account is offset by the net outflow or net export of capital. Similarly, a deficit in the current account is offset by the net import of capital. So, it won’t be wrong to say that the balance in the current account will equal the balance of the capital account to ensure equilibrium in the balance of payments.
Thus, the addition of balances of the current account, capital account, and official reserves account must equal zero.
Current account balance + Capital account balance + Reserve balance = Balance of Payments
And this is why it is usually said that the balance of payments always balances.
Official Reserve Transactions
Transactions that monetary authorities or central banks of a nation perform to manage the official foreign exchange reserves are the official reserve transactions (ORT). These transactions mainly include the sale and purchase of the currency in the exchange market, which result in a rise or drop in the official reserves. Official reserve for a country usually includes gold, foreign currencies, and SDR (special drawing right Monetary authorities usually sell foreign currency when there is a deficit. And buy the foreign currency when there is a surplus. Official reserve transactions come in the financial account of the balance of payments. When monetary authorities perform ORT to buy the home currency, it is a credit item in the balance of payments. And, if the ORT involves selling the currency, it is a debit item.
The primary purpose of ORTs is to assist monetary authorities in managing the deficit or surplus in the BoP (balance of payment). So, we can say that such transactions work as an accommodating item in the BOP.
The official reserve account is an immensely vital part of the balance of payment. It allows central banks to perform strategic functions, including balancing the balance of payment. Moreover, it gives the record of the reserves and other assets that a country holds.
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