This paper discusses how the United Kingdom can make use of its idle Exchange Equalisation Account to support its global economic objectives in an era of fiscal consolidation — when limited political appetite for further taxing and borrowing, combined with interest rates, have reduced the UK’s ability to finance its international interests.
The Exchange Equalisation Account is the government’s $190 billion reserve fund. It was established for the purpose of maintaining an exchange rate management policy. Yet with the shift towards a freely floating currency and with the growth in foreign-exchange markets, the UK’s exchange rate management policies have ceased to exist and the Exchange Equalisation Account has been left idle. With the Exchange Equalisation Account’s primary function consigned to history, the UK should give careful attention to its expansive secondary function: 'making investments to further broader economic policy aims'.
This paper discusses the financial, legal and technical considerations of mobilising the Exchange Equalisation Account. It does so with particular attention to the UK’s $40 billion in idle and illiquid Special Drawing Rights (SDRs). The illiquidity of these SDRs is a hindrance to the 'policy-readiness' of the UK’s foreign exchange reserves. This paper discusses how rechanneling those SDRs — e.g. through the purchase of an SDR bond issued by a multilateral development bank — would serve the dual function of boosting the liquidity of the UK’s foreign-exchange reserves (a key objective of the UK’s reserve managers) whilst supporting the UK’s global economic interests (providing additional financing to the MDBs). This paper also draws lessons from how other countries have made use of their idle foreign-exchange reserves to support global economic objectives, such as the United States with its Exchange Stabilization Fund in the 1980s and 1990s.
In concluding thoughts, the paper demonstrates the legal and financial viability of using the Exchange Equalisation Account to resuscitate other international financial pledges that the UK is struggling to meet given the government’s emphasis on fiscal consolidation. The example provided is the £11.6bn climate finance commitment, which can be fulfilled in a budget-neutral way by using reserve funds to purchase investment grade blue and green bonds issued by low- and middle-income countries or supranational organisations.
