^*Woon Gyu Choi is a senior economist at the IMF Institute; Sunil Sharma is the director of the IMF–Singapore Regional Training Institute; and Maria Strömqvist, a doctoral student at the Stockholm School of Economics, was a summer intern at the IMF Institute in 2005. The authors thank David Cook, Enrica Detragiache, Michael Devereux, Robert Flood, Brenda Gonzalez-Hermosillo, Leslie Lipschitz, Enrique Mendoza, Jaihyun Nahm, Jorge Roldos, Kwanho Shin, Evan Tanner, and an anonymous referee for helpful comments. The authors are also grateful to participants at the conference on "Korea and the World Economy" held in Seoul in 2006, and to the IMF Institute's weekly seminar for discussions. Si-Yeon Lee provided valuable research assistance in an earlier stage of the project, and Anastasia Guscina assisted in the collection of data.

Abstract

The paper examines the link between net capital flows and international reserves emphasizing the external financing of reserve accumulation in the context of increasing international financial integration. The paper finds that the effect of net capital flows on reserve accumulation has shifted from negative to positive for emerging markets but not for advanced countries. The empirical results suggest that in recent years emerging markets, with concerns about sudden stops in capital flows, have rapidly built up reserves through external financing with net capital inflows, whereas the advanced countries, with more secure access to international finance, have balanced reserves accumulation with investments in higher-yielding foreign assets.