International Market Operations

Foreign Exchange Operations

On almost all business days, the Reserve Bank will transact in the foreign exchange market. These routine transactions are executed in ways that minimise their impact on exchange rates and on market conditions more generally.

Many of the Reserve Bank’s transactions arise from the provision of foreign exchange services to its clients, the largest of which is the Australian Government. In the normal course of events, the Bank covers its foreign currency sales to the Government by purchasing matching amounts in the spot market. During periods where the market for Australian dollars is stressed, the Bank has the option of drawing on its existing holdings of foreign currency to meet the demand from the Government and other clients. These reserves would subsequently be replenished when the Bank judged that market conditions had stabilised.

The Reserve Bank also regularly transacts in the market to manage its portfolio of foreign currency assets. In addition to spot market transactions, the Reserve Bank also makes use of foreign exchange (and ‘cross-currency’) swaps, whereby one currency is exchanged for another with a commitment to unwind the exchange at a subsequent date at an agreed (forward) exchange rate. The Bank executes swaps against Australian dollars for periods of up to 5 years.

Some transactions undertaken by the Reserve Bank may be intended to influence the exchange rate or conditions in the market for foreign exchange. These ‘intervention’ operations have become less frequent over time as the market has developed. Nonetheless, the Reserve Bank retains the discretion to intervene in the foreign exchange market to address dysfunction and/or a significant misalignment in the value of the Australian dollar. The Bank publishes data on daily foreign exchange intervention on its website (with a lag; see Statistical Table A5).

As a participant in the foreign exchange market, the Reserve Bank conducts its activities in a manner consistent with the principles of the FX Global Code. (See the Reserve Bank’s Statement of Commitment.)

Reserves Management

Australia’s official reserve assets include foreign currency assets, gold, Special Drawing Rights (SDRs, an international reserve asset created by the IMF) and Australia’s reserve position in the IMF. Most of these assets are owned and managed by the Reserve Bank. The Australian Government owns Australia’s reserve position in the IMF and the bulk of Australia’s SDR holdings.

The Bank holds foreign currency assets to facilitate policy operations in the spot foreign exchange market and to ensure that Australia’s commitments to the IMF could be met during periods of market stress. Holdings of foreign currency assets can expose the Bank’s balance sheet to foreign currency risk and, as with the Bank’s portfolio of domestic securities, foreign currency assets may carry interest rate, credit and liquidity risks. The optimal level of reserves represents a trade-off between exposures to these risks and the need to meet the Bank’s policy objectives.

Foreign currency reserves are invested in assets of high credit quality and with sufficient liquidity to allow the Bank to meet its policy objectives. To the extent that foreign exchange swaps have been used to fund its foreign currency assets, the Bank will have forward commitments to deliver that amount of foreign currency against the receipt of Australian dollars. In its published data on official reserves, the Bank includes data on foreign currency commitments, including those due in the coming 12 months (see Statistical Table A4 – ‘net forward foreign currency commitments: short-term’). Deducting these short-term commitments from foreign currency assets provides a measure of the foreign currency liquidity available to the Bank to meet its policy objectives.

Diversifying the Reserve Bank’s foreign currency risk across a range of currencies assists in mitigating financial risk (Table 1). The investment process for foreign currency assets is guided by an internal benchmark that represents the Bank’s best estimate of the combination of foreign currency investments that maximises return over the long run, subject to an acceptable level of risk and the overarching requirements for security and liquidity.

Investments within the benchmark currencies are limited to deposits at official institutions (such as central banks) and debt instruments issued (or guaranteed) by sovereign, quasi-sovereign and supranational entities. Sovereign credit exposures are limited to the United States, Germany, France, the Netherlands, Canada, Japan, the United Kingdom, China and South Korea.

The Reserve Bank also has investments in a number of Asian debt markets through participation in the EMEAP Asian Bond Fund (ABF) Initiative. This was established to assist bond market development in the region following the Asian currency crisis in the late 1990s. The Bank has modest holdings in a local currency denominated fund, ABF2, which is managed by external managers.

The Reserve Bank’s gold holdings amount to 80 tonnes. As a participant in the gold market, the Reserve Bank conducts its activities in a manner consistent with the principles of the Global Precious Metals Code. (See the Reserve Bank’s Statement of Commitment.)