Does international reserve accumulation crowd out domestic private investment?

Abstract

Foreign exchange reserve accumulation is one of the preferred strategies to protect against susceptibility to financial crises. At the same time, maintaining a healthy international reserve position has the potential to promote domestic investment by reducing the cost of foreign borrowing through improving international creditworthiness. However, contractionary monetary policy in the form of sterilization operations implemented as part of reserve accumulation strategy could crowd out financing for domestic investment. This study examines the relationship between foreign reserve accumulation and domestic private investment by undertaking a dynamic panel data econometric analysis covering 58 countries over the period 2000–2014. The findings suggest that reserve accumulation is positively associated with domestic private investment in the long-run.