Introduction

The economic policy response to prevent the cycle of speculative attack-capital, flight-financial crisis, adopted by both crisis-affected and other non-affected emerging economies since Mexico's 1994–95 financial crisis, but particularly since the 1997–98 East Asian crisis, has been simply to increase liquidity through the accumulation of international reserves. Developing countries' international reserves ‘have risen from 6–8 per cent of GDP during the 1970s and 1980s to almost 30 per cent of GDP by 2004’ (Rodrik, 2006, 255). Furthermore, today, around two-thirds of international reserves are held by developing countries (Aizenman, 2007).

The dominant explanation for the build-up of reserves is that it simply represents precautionary behaviour designed to provide insurance against the high output and other costs associated with earlier crises. Countries following this strategy are evidently hoping to emulate those economies that escaped speculative attacks and/or capital flight (e.g., Chile, Columbia, China and India) and maintained policy autonomy, thereby providing ‘a way of reducing the risks of future crises and of minimizing the need to turn to the IMF if crises occurred’ (Bird and Mandilaras, 2005, 85). A second, alternative but not exclusive, explanation for reserves accumulation identifies it with an active policy of export-led industrialization characteristic of several countries in East Asia (especially China). This is the mercantilist interpretation of reserve accumulation, in which increased reserves are a by-product of maintaining a competitive exchange rate designed to expand tradeable production (see Aizenman and Riera-Critchton, 2006).