New Zealand’s government has provided the central bank with more capital and an indemnity that allows it to build its foreign reserves, giving it more scope to intervene in currency markets if it needs to.
(Bloomberg) — New Zealand’s government has provided the central bank with more capital and an indemnity that allows it to build its foreign reserves, giving it more scope to intervene in currency markets if it needs to.
The government added NZ$500 million ($308 million) to the Reserve Bank’s balance sheet in early July, according to a Treasury Department report to Finance Minister Grant Robertson. Details of how much the RBNZ’s foreign reserves will increase or what its intervention capacity will rise to were redacted. In June, its intervention capacity was NZ$12.9 billion, latest data on the bank’s website show.
The government and the RBNZ announced a new foreign currency reserves framework in January, saying the level of reserves had been largely unchanged since 2007 and needed to increase. At the time, the RBNZ declined to specify the size or composition of the increase and Governor Adrian Orr said the transition would “take place over a number of years” to minimize market impact.
The capital injection and indemnity “reduce the likelihood that the Reserve Bank would have to operate with low or negative equity in the event of a loss resulting from a large exchange rate movement,” an RBNZ spokesman said Wednesday in Wellington. “The indemnity covers specific foreign exchange losses arising as a result of a foreign currency intervention.”
In the May 19 report to Robertson released late Tuesday, the Treasury said the increase in reserves will improve the nation’s economic resilience by allowing the RBNZ to intervene in currency markets to support its financial stability and monetary policy objectives.
“The Bank’s current level of foreign reserves for intervention have not been updated to reflect the growth in the New Zealand economy and global financial markets and may no longer be sufficient in some scenarios,” it said.
Additional Risk
While the extra capital doesn’t add to overall Crown debt, the additional financial backing does enable the RBNZ to take on additional risk, and losses or gains arising from these risks would flow through to the Crown, the Treasury said.
The amount of extra capital has been determined by the RBNZ’s loss modeling work, based on severe but plausible scenarios and the Treasury is comfortable with this assessment, it said. The RBNZ had confirmed that the amount was sufficient provided an indemnity was provided, it said. The size of the indemnity was not disclosed.
The deed of indemnity was agreed July 26, according to a document on the RBNZ website. It would covers losses incurred by the RBNZ using its hedged foreign reserves to undertake an intervention.
“An indemnity would cover situations where the Bank intervenes in the foreign exchange market beyond its positive net foreign asset position where it is effectively ‘short’ foreign currencies,” the Treasury said. “We expect this would be rare.”
A currency intervention using hedged reserves would typically only be performed by the RBNZ for the purpose of financial stability, such as stabilizing financial markets when foreign exchange markets are dysfunctional, or when the convertibility of the New Zealand dollar for foreign currency is impaired, the Treasury said.
Providing an indemnity was preferable to a much larger capital provision upfront, the Treasury said. There is no time limit on the indemnity but it and the overall foreign reserves framework will be reviewed every five years.
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