Why the foreign exchange reserves of the Czech Central Bank cannot help the budget now

There is ongoing discussion on whether India’s forex reserves can be used to fund India’s infrastructure.

Similar discussion is going on in Czech Republic as well.

Jan Kubíček, member of the Czech National Bank (CNB, their central bank) banking board writes why the forex reserves cannot help the govenment budget:

What are the foreign exchange reserves of the CNB, what are they used for and how does the bank deal with them? And could they be used to finance public investments? Jan Kubíček, a member of the banking board of the CNB, explains the questions surrounding the enormous foreign exchange reserves in the commentary.

In recent weeks, there has been an interesting discussion in the media about the potential role of the Czech National Bank’s foreign exchange reserves as a source of funding for public investments. The fact is that the CNB’s foreign exchange reserves are relatively large: they fluctuate around the value of three trillion crowns and, coincidentally, are similar in size to the current amount of public debt.

It is therefore only natural that at a time when public finances are going through a painful recovery, questions arise as to whether and possibly how they could be involved for the benefit of public finances. Why should the central bank “sit” on the reserves and watch in comfort as they grow thanks to the income from them, while the other branches of the state have tight budgets?

Is Forex reserve really a reserve?

The answer needs to start with what foreign exchange reserves are not. The label “reserve” can lead to the idea that it is a kind of reserve sum saved by the side in case of emergency, similar to how you can have a reserve set aside in the family budget. Indeed, some countries have such funds in which funds are accumulated, usually from mineral wealth or from past investments – such as the Norwegian Government Pension Fund, whose assets correspond to about 1.5% of the value of all listed stocks in the world. And such a fund can (and does) more or less support the budget. But the foreign exchange reserves of the CNB are not a fund of this type.

The current high volume of foreign exchange reserves arose somewhat as a by-product of the past monetary policy, when the central bank bought foreign currency for many reasons. The reasons for purchases of foreign currency were diverse and sometimes debatable: whether it was a so-called exchange rate commitment (i.e. the de facto artificial weakening of the koruna between 2013 and 2017), or the purchase of a net inflow of European funds. What is significant, however, is that together with the purchased reserves, the CNB’s debt to the banking sector also grew. The central bank bought reserves for newly issued crowns, which it immediately withdrew from the market by offering commercial banks to actually deposit them with it.

In simple terms, it can be said that our foreign exchange reserves are actually bought on debt, which today has quite a lot of interest. It is clear from this that, in addition to revenues, the holding of reserves also has its costs. Foreign exchange reserves are simply an integral part of the central bank’s balance sheet, not something that the CNB only manages in the same way as when an investment company manages (separately from its assets) funds entrusted to it by investors. They are therefore a profitable asset, but there is an interest-bearing debt against it.

But the fact is that while debt bears short-term interest, reserves can be invested in longer-term and riskier instruments, so on average they should earn more than what the interest costs on the reserves are. So couldn’t at least this difference in revenue and costs help the public finances? The answer is yes: that’s how the system is currently set up anyway.

The other problem is CNB has accumulated losses in the last few years. So the losses have to be paid first.