International Market Operations

Foreign Exchange Operations

On most business days, the Reserve Bank transacts in the foreign exchange market. These transactions are principally to facilitate client requirements, with the vast majority of this activity arising from the provision of foreign exchange services to the Australian Government. In the normal course of events, the Bank covers its sales of foreign currency to the Government by purchasing foreign currency in the market. The Reserve Bank has an existing stock of foreign currency assets and, during periods where the market for Australian dollars is stressed, it has the option of drawing on these holdings 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 transacts in the market to manage the currency risk on its portfolio of foreign currency assets. As discussed below, the foreign currency assets on the Bank's balance sheet are managed against an internally constructed benchmark. Deviations of the currency composition of these assets from benchmark weights, which occur due to currency and asset valuation changes, lead to transactions for rebalancing purposes.[1] These rebalancing transactions, and any transactions necessary to accommodate a change in the benchmark weights, involve the Reserve Bank operating in both the foreign exchange spot and swap markets.

Some transactions undertaken by the Reserve Bank are intended to influence the exchange rate or conditions in the market for foreign exchange. Australia has operated a floating exchange rate regime for over thirty years and, over time, intervention by the Bank has become less frequent as the market has developed, hedging foreign currency risk has become more efficient and as awareness of the benefits of a floating exchange rate regime has grown. Nonetheless, the Reserve Bank has always retained the discretion to intervene in the foreign exchange market to address dysfunction and/or a significant misalignment in the value of the Australian dollar. Transactions undertaken for these purposes would usually be effected in the spot market. The Bank provides data on daily foreign exchange intervention on its website (with a lag).

The Reserve Bank also operates in the foreign exchange market from time to time to manage the level of its foreign currency holdings. To the extent that these transactions involve a change in the outright foreign currency position of the Bank, they could be inferred as constituting intervention. In practice, however, these transactions differ from intervention in that they are executed in a way that minimises their impact on the exchange rate and on market conditions more generally. They are typically executed in the spot market in small amounts over long periods.

The Reserve Bank’s foreign currency holdings are also effected by the use of foreign exchange swaps. To implement monetary policy, the Reserve Bank may supplement its operations in the domestic securities market with foreign exchange swaps against the Australian dollar. These transactions are used in the same way as repurchase transactions in the domestic market to alter the profile of Australian dollar liquidity flows into and out of the banking system. The Bank is also an active user of foreign exchange swaps when managing the cash held within its foreign currency portfolio. Foreign exchange swaps executed by the Bank either to supplement domestic market operations or to manage cash in the foreign currency portfolio are for short periods of usually no more than three months.

In addition to these shorter term swap transactions, the Bank executes long-term foreign exchange swaps against Australian dollars for periods of up to 5 years. These longer term transactions are used to obtain foreign currency that can be used to meet Australia’s commitments as a member of the IMF (e.g. providing foreign currency to the IMF to support its lending activities). The Reserve Bank's use of both shorter- and longer-term foreign exchange swaps does not change the outright foreign currency position of the Bank and has no implications for the value of the Australian dollar.

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

With the exception of its reserve position in the IMF, Australia's holdings of official reserve assets are held on the balance sheet of the Reserve Bank. Official reserve assets held by the Bank comprise both foreign currency assets as well as gold. The Bank holds foreign currency assets mainly to facilitate its policy operations in the spot foreign exchange market, although these assets are also used to augment operations in the domestic money market and to meet Australia’s IMF commitments (see above). Outright holdings of foreign currency assets (i.e. foreign currency not obtained from swaps) 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.

In its published data on official reserves (see Statistical Table A4), the Bank includes a measure of its foreign currency assets that deducts net foreign currency commitments due in the coming 12 months (see Statistical Table A4 – ‘foreign currency liquidity (FX)’). These short-term net foreign currency commitments capture foreign currency that the Bank is due to deliver under short-term swap agreements (those maturing within 12 months). Deducting these net short-term foreign currency commitments from foreign currency assets provides a measure that represents the foreign currency liquidity available to the Bank to meet its policy objectives. The Bank can add to its foreign currency liquidity position either by obtaining foreign currency in the spot market or via longer-term swaps.

The mandate under which reserves are managed requires investments in assets of high credit quality and that the portfolio has sufficient liquidity to allow the Bank to meets its policy objectives. The major risks to the balance sheet are mitigated where possible, chiefly by holding a diversified set of currencies. The investment process for outright holdings of foreign currency assets is guided by an internal benchmark, which represents the Reserve 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.

Table1: The Benchmark Portfolio
(June 2020)
USD EUR JPY CAD GBP RMB KRW
Currency allocation
(% of total)
55 20 5 5 5 5 5
Duration (months) 6 6 < 3 6 3 18 18
Source: RBA

Investments within the benchmark currencies are limited to sovereign, quasi-sovereign and supranational debt instruments and cash investments secured by high-quality debt under repurchase agreement. 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 in the development of bond markets in the region in the wake of 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 and sits outside the Bank's internal benchmark framework.

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.)

Footnote

Benchmark weights are reviewed regularly but are only changed in response to significant changes in market conditions. [1]