Reserves accumulation in African Countries: sources, motivations, and effects

Abstract

African countries have accumulated substantial foreign currency reserves in recent years, mostly from higher commodity exports as well as aid flows. In the context of macroeconomic stabilization, which remains at the forefront of national economic policymaking and aid conditionally, African countries are induced to hold reserves to allow monetary authorities to intervene in the markets to influence the exchange rate and inflation. Adequate reserves also allow the country to borrow from abroad and to hedge against instability and uncertainty of external capital flows. However, reserve accumulation can have high economic and social costs, including a high opportunity cost emanating from low returns on reserve assets, losses due to reserve currency depreciation, and forgone gains from investment and social expenditure that could be financed by these reserves. Therefore, African countries need to have a better understanding of the determinants and economic costs of reserve accumulation and to design optimal reserve management strategies to minimize these costs. The study uses panel data from 21 African countries to examine the causes and economic implications of reserve accumulation with focus on the impact on the exchange rat, inflation, and public and private investment.