Mention the Advantages and disadvantages of holding a large amount of international reserves

Advantages and disadvantages of holding a large amount of international reserves are discussed below-

Advantages of holding a large amount of international reserves:
• Countries that hold a large amount of international reserves are able to solve short-term external financial debt without affecting the exchange rate.

• The bigger the reserve held, the more a country can spend (investments and embark on new projects).

• Countries holding bigger reserves would be able to avoid current account deficits since future current account deficits would be better financed (running down of reserves can neutralize the effects of capital outflows).

• Reserves allow countries to adopt slower speeds of adjustment when tackling balance of payments crisis.

• They also contribute to the perceived creditworthiness of countries, lessening the occurrences of crises (in the future). For example, after the financial crisis, many countries increase their holding of international reserves to help them tide over the crisis, lessen its impact, and/or avoid such situations in the future.

Disadvantages of holding a large amount of international reserves:
• Holding international reserves would imply a contemporary output loss (opportunity cost).

• Balance of payment surpluses could reflect undervalued currencies, low levels of domestic consumption and high levels of saving, the pursuit of tight monetary and fiscal policy, or commercial policy discouraging imports and encouraging exports.

• The more international reserves a country holds, the more exposed it is to fluctuations of foreign asset prices, increasing occurrences and susceptibility to financial crises.