An international reserves variation threshold to increase loan funding

Abstract

In this article we propose a methodology for the calculation of an international reserves variation threshold that defines the lending decisions of international creditors to developing countries. If the change in net international reserves of the borrowing variation is above that of the threshold, the creditors are willing to lend more. Otherwise, if that change is below the threshold, there will be capital flight. Such a threshold depends on the stocks of debt and international reserves, as well as on the perception of the default risk of the country to honour its debts. Using that threshold, we perform a counterfactual exercise to calculate the time series of international reserve levels that minimize the total cost of reserves holding, namely, the cost of possible illiquidity of the country plus the opportunity cost of holding international reserves. We illustrate the methodology by applying it to five Latin American countries: Argentina, Brazil, Chile, Mexico and Peru. © 2021, The Author(s), under exclusive licence to Springer-Verlag GmbH, DE part of Springer Nature.