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 the 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 the year on year international payments. Hence, sometimes it is also referred and linked to Balance of Payments. The government or the country’s central bank 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.
Along with holding the securities, this account also helps to balance the BOP annually. 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.
Importance of Official Reserve Account
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.
- Central bank uses it to balance the BOP in case of a deficit.
- Central bank may also use this account to change the exchange rate to support the 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, 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.
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, country’s foreign exchange reserves and more.
Components of Balance of Payments
The Balance of Payments has three parts/categories – Capital Account, Current Account and Financial Account.
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 does not affect the income, production and savings of the country. There are very few and rare transactions happens in the capital account. Therefore, capital account usually remains the smallest part of BOP.
Current Account, on the other hand, 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 people of the country provides 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 the asset ownership -domestic as well as foreign. Whenever there is increase is foreign ownership of domestic assets this account will have a deficit and vice versa. Effectively it would mean that the country is selling its assets to foreigners. However, in case of surplus in this account would mean that the country has possession of foreign assets and thus purchasing those assets.
In the case of net capital outflows (or surplus in the capital account), the balance in the official reserve account would rise. And, in case of net capital inflows (or deficit 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, overall we can say that the addition of the current account balance, capital account balance and the balance of the official reserves account must equal to zero.
Current account balance + Capital account balance + Reserve balance = Balance of Payments
And this is why it is usually said that Balance Of Payments always balances.
Official Reserve Transactions
These are the transactions that result in rise or drop in the official reserves. Or, we can say that such transactions result in a change in the country’s reserves. This change usually occurs when the government uses the reserves to meet the deficit in the Balance of Payments (BOP).
Such transactions are immensely crucial as they aid in balancing the BoP.
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.