Reserve Bank builds war chest of foreign reserves to support the dollar if there’s a crisis

Reserve Bank governor Adrian Orr says the transition to a higher level of foreign reserves will take place over a number of years. Photo / Jed Bradley

The Reserve Bank of New Zealand (RBNZ) is slowly building a war chest of foreign reserves to give itself the muscle to support the New Zealand dollar (NZD) in the event of a crisis.

In January, the central bank announced it would accumulate additional foreign reserves to help it more effectively intervene in the currency market if the NZD tanked or soared.

The RBNZ said it would only intervene in “rare” and “extreme circumstances” to maintain financial stability or help it keep inflation and employment in check.

The central bank noted the level of foreign reserves – safe and liquid assets held in currencies, like US dollars, Euros and Australian dollars – it held hadn’t changed much since 2007, so it was time for an update.

The RBNZ said it would remain tight-lipped on the amount and composition of foreign reserves it would accumulate, due to market sensitivity. It also said it would bolster its reserves over a number of years to minimise the impact on the market.

Nonetheless, the central bank made a splash in July, selling $4.0 billion of NZD and increasing its foreign currency intervention capacity from $12.9b to $16.7b.

This was a seismic move, much greater than the bank had made in recent history.

New data released on Wednesday showed the RBNZ took a bit of a breather in August, buying some NZD and increasing its foreign currency intervention capacity by $874 million.

Market participants are now pondering how many more foreign assets the RBNZ will accumulate, and how it will go about doing so.

Westpac chief economist Kelly Eckhold was surprised the bank sold a whopper $4b of NZD in July, explaining it might’ve done so to get its reserves up to the minimum it wanted to hold.

Westpac’s head of New Zealand strategy Imre Speizer believed this level would put it more on par with its counterparts overseas.

While the RBNZ made a bold start to the process of building its war chest of foreign reserves, Speizer said it didn’t ruffle the market. So, it was a success in that regard.

Eckhold guessed the RBNZ might want to ultimately lift its $17.6b of foreign currency intervention capacity by another $12b.

He acknowledged holding more assets exposed the RBNZ’s balance sheet to exchange rate fluctuations.

Accordingly, Finance Minister Grant Robertson in July gave the RBNZ $500m of additional capital to reduce the likelihood of it operating with low or negative equity in the event of a loss resulting from a large exchange rate movement.

Robertson also provided the RBNZ with a backstop, or indemnity, covering specific foreign exchange losses arising from a foreign currency intervention.

The RBNZ in January assured, “New Zealand is committed to maintaining a free-floating currency.

“We do not seek to maintain a certain level of the exchange rate and we will continue to only intervene in the foreign exchange market in extreme circumstances to support our policy objectives …

“Due to market and policy sensitivities, we do not intend to make public any further details on the size or composition of this increase. However, our foreign reserves holdings will continue to be published on our website on a monthly basis.”

The RBNZ will next provide an update on its website on October 27.

Jenée Tibshraeny is the Herald’s Wellington Business Editor, based in the Parliamentary press gallery. She specialises in government and Reserve Bank policymaking, economics and banking.