The currency denomination of New Zealand’s unhedged foreign reserves

Abstract

In July 2007 the Reserve Bank added un-hedged foreign currency assets to its foreign reserves portfolio. This means that some of the Bank’s reserves are now funded directly in New Zealand dollar (NZD)-denominated borrowings as opposed to in foreign currency. When reserves are fully hedged, foreign currency assets are matched with foreign currency liabilities, leaving little net foreign exchange (FX) risk. When reserves are held on an unhedged basis, the level of FX risk is greater and the relative rate of return associated with alternative foreign reserve currencies are more variable. These different properties make the composition of the basket of foreign reserve currencies the Reserve Bank holds more important and requires the development of a strategic FX benchmark to guide the investment of the Bank’s unhedged reserves. This article describes the development and implementation of the Reserve Bank’s new strategic FX benchmark.