This page explains why we hold foreign reserves and provides an overview of the Foreign Reserves Management and Coordination Framework required under the new Reserve Bank of New Zealand Act 2021.
We hold and manage foreign reserves in order to be able to intervene in the New Zealand dollar (NZD) market for financial stability or monetary policy reasons. Foreign reserves are safe and liquid assets held in currencies, such as United States dollars, Euros, and Australian dollars. Holding foreign reserves is important for our credibility as the Reserve Bank of New Zealand, and it ensures global confidence in the NZD and wider New Zealand economy.
Why do we hold foreign reserves?
New Zealand has a floating exchange rate regime, which means we do not seek to maintain a certain level for the NZD relative to other currencies. This means that the level of the NZD should reflect the supply and demand of NZD, relative to other currencies in the world.
Most major economies in the world — such as Australia, the United States, Canada, the European Union, and the United Kingdom — all have floating exchange rates.
The foreign exchange market is what all our exporters, importers and investors use to exchange New Zealand dollars for foreign currency. The level and functioning of the NZD market impacts these stakeholders, as well as the wider New Zealand economy.
Foreign reserves are assets held in currencies (other than the country’s own currency), which allow the central bank to be able to buy or sell its own currency in exchange for these foreign assets or reserves. It is standard practice for central banks globally to hold foreign reserves, to support their respective currency markets and economies.
We hold foreign reserves so that there is confidence that we are ready and able to transact in the foreign exchange market, if it is ever needed. It is important that everyone has confidence in this market, in order to support the stability of the New Zealand economy more broadly.
Changes to foreign reserves under the new Reserve Bank Act
The Reserve Bank of New Zealand Act 2021 gives us the power to deal in foreign exchange, in pursuit of our monetary policy, financial stability, and other central bank objectives. Holding foreign reserves means we are ready and able to intervene in the NZD at all times.
In a crisis, we may intervene in foreign exchange markets for financial stability reasons, in order to facilitate market functioning during a period of severe market dysfunction or breakdown in the NZD. Holding foreign reserves for this objective acts as a kind of insurance against a major threat to financial stability which might occur after a crisis situation — such as a big earthquake, an outbreak of foot and mouth disease, or a global financial or economic shock, for example, the Global Financial Crisis or COVID-19.
We are also able to intervene in foreign exchange markets for monetary policy reasons. These actions are uncommon and are not intended to maintain a stable or specific level of the exchange rate. Monetary policy interventions are consistent with New Zealand’s floating exchange rate regime and aimed at smoothing medium-term fluctuations in the NZD.
Foreign Reserves Management and Coordination Framework
The new Act requires the development and publication of a Foreign Reserves Coordination Framework (the Framework) by the end of 2022. The Framework aims to ensure accountability and transparency around our management and use of foreign reserves.
The Framework is an agreement between the Board of the Reserve Bank and the Minister of Finance. The Framework outlines the respective interests and roles that we have with the Crown in the management and use of foreign reserves.
We will review the Framework with the Treasury at least every 5 years. This enables the government to have regular input into how we manage and use foreign reserves and ensure we have the appropriate capacity to meet our monetary policy, financial stability and other central bank objectives.
While the Minister retains the power to be able to direct the Reserve Bank to intervene, we can notify the Minister when this would impede our ability to meet our core objectives.
Agreements with foreign official institutions
We have bilateral credit lines in place with several foreign official institutions to:
- enhance the liquidity of our foreign reserves portfolio
- underpin the function of the foreign exchange market
- support domestic financial stability.
This gives confidence that the New Zealand foreign exchange market will continue to function effectively for all participants, even when ordinary sources of foreign currency liquidity might be impaired.