What are EM reserves for?

EM central banks have increased reserves over the last decade yet now that some currencies are under attack, governments are using import restrictions and higher interest rates to preserve currency values. Is this a good idea? The thought was to have reserves would be available to offset a sudden stop, a quick reversal of short term capital flows. These has been happening in some of the current account deficit countries. The size of the outflows has not matched 1998 levels, but flows have certainly moved away from the entire EM sector. A good question is what is the purpose of these reserves if they are not used when there is a large depreciation. There have been declines and in the case o f India the data of the size of the decline surprised the market. Still, there is a question of what constitutes a crisis that would call for purchase intervention. 

Perhaps these reserves are being held back for when there is an increased speculative attack on the currency. What would be those attack conditions? Certainly the central banks are not going to provide the details of what constitutes an attack. It is also possible that these countries are willing to accept some depreciation in order to improve exports. The capital controls are in place to control any excessive outflow. Contain the potential damage. Still, it seems like the focus of EM currency depreciation has been on those countries that were in sad current account positions. It does not seem as though these were currency depreciation by choice.

There has been a movement toward structural policy choice tools to adjust capital flows and currency chnages. Less use of reserves and more use of regulation and capital flow controls. This is a result of the research that shows the futility of currency intervention; however, if that is the case,  foreign exchange reserves are not needed. A final view is some of the reserve accumulation was not intended but the result of trying to better manage or offset the dollar depreciation desires of the Fed.

Much of what we are seeing now is associated with the potential policy changes at the Fed. The Fed eases and the rest of the world has to react. The Fed may tighten and the rest of the world has to adapt.