What Are International Reserves?
International reserves are any kind of reserve funds, which central banks can pass among themselves, internationally. International reserves remain an acceptable form of payment among these banks. Reserves themselves can either be gold or a specific currency, such as the dollar or euro.
Many countries also use international reserves to back liabilities, including local currency, as well as bank deposits.
Examples of International Reserves
Special drawing rights (SDR) are another form of international reserves. The International Monetary Fund (IMF) created SDRs in 1969 in response to concerns about the limitations of gold and dollars as the only means of settling international accounts. SDRs can enhance international liquidity by supplementing standard reserve currencies. Member countries' governments back SDRs with their full faith and credit.
A SDR is essentially an artificial currency. Some describe SDRs as baskets of national currencies. IMF member states holding SDRs can exchange them for freely usable currencies (such as USD or Japanese Yen), either by agreeing among themselves or via voluntary swaps. In addition, the IMF may instruct countries with stronger economies or larger foreign currency reserves to buy SDRs from its less-endowed members. IMF member countries are able to borrow SDRs from IMF reserves at good interest rates. (They generally use these to adjust their balance of payments to become more favorable.)
The IMF also uses SDRs for internal accounting purposes as the SDR is the unit of account of the IMF, in addition to acting as an auxiliary reserve asset. SDRs’ value, which the IMF sums up in U.S. dollars, is calculated from a weighted basket of major currencies: Japanese yen, U.S. dollars, Sterling, and the Euro.
International Reserves v. Foreign Exchange Reserves
Similar to international reserves, foreign exchange reserves are also reserve assets, which a central bank holds in foreign currencies. These may include foreign banknotes, bank deposits, bonds, treasury bills, and other government securities. Colloquially, the term foreign exchange reserves may also mean gold reserves or IMF funds.
Central banks may use foreign exchange reserves to back liabilities on their own currency. In addition, foreign exchange reserves may be useful in influencing monetary policy. In general, foreign exchange reserves allow a central government more flexibility and resilience in volatile market conditions.
For example, if one or more currencies crash and/or become rapidly devalued, a central bank may balance this temporary loss with other, more highly valued and/or stable, currencies, in order to help them withstand markets shocks.