What causes changes in the amount of foreign reserves

Fluctuations stemming from the national economy

Changes in the central bank's foreign exchange reserve constitute a significant indicator in the context of the general macroeconomic analysis, as then also the balance of payments reserves undergo changes.

If the inflow and outflow of foreign currencies stemming from the international economic relations of the country (trade, investments, etc.) are more or less in balance, also the changes in the balance of payments reserves remain minimal. However, if in case of a current account deficit the foreign money flowing into the country in the form of financial investments fails to guarantee a sufficient financial account surplus, the balance of payments reserves will decrease and it may seem that the foreign exchange reserves are "eaten away" in order to acquire the required import and the solvency keeps decreasing.

But in order to avoid false interpretations, long-term trends and short-term fluctuations must definitely be distinguished between. In case of a small country, the latter may even be caused by one large-scale transaction.

Fluctuations stemming from the banking sector

The size of Eesti Pank's foreign exchange reserves is influenced by the amount of banks' reserves in Eesti Pank on the day monitored. Since the second half of 1999, when the new rules for depositing minimum reserves stepped into force, the fluctuations of these reserves have been relatively miniscule in Estonia.

The reserves are linked to the Estonian kroon's monetary growth

According to the law, Eesti Pank may issue additional Estonian kroons (base money) only being secured by foreign currency. According to the current practice the central bank issues Estonian kroons mainly in two forms.

Firstly: Upon issuing cash the central bank incurs a liability to the cash owners.

Secondly: Commercial banks buy so-called account money from Eesti Pank for foreign currencies, which remains on the balance sheet of Eesti Pank as a liability to commercial banks.

Although fluctuations also occur in cash demand, the dramatic and sudden changes in the demand for base money usually stem from changes in the reserve requirement required from commercial banks.

As in the conditions of a currency board the reserve requirement is extraordinarily important, also the regulations on depositing the reserve requirement and calculating the reserve requirement amount in Estonian banking are relatively complex, specific and enable a flexible approach. For instance, banks have to comply with the reserve requirement as a monthly average: this means that on some days a bank may deposit over 15% on the reserve account, on other days less - depending on what is necessary and beneficial. However, a certain minimum level - 40% of the kroon reserve requirement to be deposited at the central bank must be guaranteed at all times.