The United Kingdom's Official Reserves of Foreign Currency and Gold
The Financing of the Reserves
It is possible for the Reserves to be financed (that is, "raised") in two principal ways. Either sterling can be sold for foreign currency, or foreign currency can be borrowed. Both methods have been employed in funding the Reserves in recent years.
Reserves financed by borrowing are known as "the borrowed
reserves". This foreign currency borrowing can take two broad forms. From time
to time foreign currency has been borrowed directly, by issuing securities
denominated in foreign currencies. The most recent example was the
UK government's US dollar bond
issue announced in June 2003. Alternatively, securities may be issued in
sterling and the proceeds "swapped" into foreign currency, which also gives
rise to a foreign currency liability *. The choice
between these methods of borrowing foreign currency is determined chiefly by
their relative cost.
The 1979 Exchange Equalisation Account Act does not permit the EEA to borrow. The National Loans Fund, which is another government account, undertakes such transactions.
Therefore, where the foreign currency reserves are financed by foreign currency liabilities, the debt is issued and held on the NLF. The foreign currency raised is transferred to the EEA in return for payment in sterling. The sterling used to make this payment is advanced to the EEA from the NLF. Upon consolidation of the two accounts, the inter-account sterling transactions cancel out leaving the NLF with a foreign currency liability to the market hedged by a foreign currency asset on the EEA.
The portion of the reserves that has not been funded by borrowing foreign currency is known as the "net reserves". It is in effect HMT's net asset position in foreign currency and gold. Broadly speaking the net reserves can be thought of as having been financed over time by sales of sterling for foreign currency **.
The published information on the Reserves shows what portion is "borrowed" and what "net". See the Published Information on the Reserves section.
* The Agency that issues debt in sterling on behalf of the government is the Debt Management Office (DMO).
** There are however other sources: first, the EEA's retained profits, and second the EEA's net SDR liability (ie the extent to which the UK has sold SDRs over time such that its holdings of SDRs are below its cumulative allocation. This is explained in the Links to the International Monetary Fund Section.
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