The determinants of the level of international reserve holdings in Kenya an empirical analysis

Abstract

International reserves form an integral part of a nation's overall portfolio of foreign assets . These reserves are held by monetary authorities so as to enable intervention in the foreign exchange market, finance an external imbalance, provide a buffer to cushion the economy against future adverse fluctuations and form part of the basis for money supply. This paper sought to find out the determinants of the level of these international reserves in Kenya. It utilized yearly data of the variables used. The time series properties of these variables were explored in great detail. The variables were found to be non-stationary and cointegrated. To run a non-spurious regression, the data used are in first difference and an ECM incorporated. The findings of the paper are that international reserve holdings are positively related to the country's wealth (proxied by GDP), the level of variability of international payments. and the openness of the economy. On the contrary, reserve holdings are negatively related to [he level of imports, the nominal exchange rate and domestic credit. A number of diagnostic tests were conducted and proved that the model tracks the data well. The instability of the parameters of the model is attributed to the shifts in exchange rate regimes.