Four snippets of notes on the CNB's foreign exchange reserves and income statement
Economic commentary by Jaromir Šindel, Chief Economist of the CBA
This text summarises four selected excerpts from my remarks shared during a panel discussion on FX reserves and central bank management on the occasion of the CNB Discussion Forum in Pilsen on 29 April 2025. The four nuggets: accounting loss vs. tangible costs of the CNB's monetary policy; the accumulation of CNB FX reserves and Czech bank liquidity; the dividend from the central bank to the Polish state budget; the long-horizon argument in FX reserve diversification clashing with proposals for a lower level of CNB FX reserves.
Main conclusions: 1) The CNB's loss is currently not just an accounting loss, but the solution to the higher costs of implementing monetary policy lies in increasing the economy's potential; 2) the high reserves are not only a remnant of the foreign exchange interventions of 2013-2017, but also reflect the conversion of EU funds on the CNB's balance sheet, which essentially redistributed the associated costs and profits in the economy; 3) the "dividends" to the Polish state budget have averaged 0.22% of GDP since 2011, which is illustratively in Czech real terms EUR 17.5 billion. CZK in 2024 prices.
For more discussion with charts below and more snippets see the entry on the CNB website.
1. The CNB's loss is currently not just an accounting loss, but the solution to the higher costs of implementing monetary policy lies in increasing the economy's potential
The CNB's performance is strongly influenced by the development of foreign exchange reserves, which affects the central bank's income statement through two channels. First, through the revaluation of foreign assets due to exchange rate movements. According to BR member Jan Kubíček (Plzeň, 29 April 2025), a CZK 1 appreciation of the koruna against the euro leads to a negative revaluation of the current (koruna) level of foreign exchange reserves by CZK 130 billion. This roughly corresponds to my estimate that a 1% revaluation of the exchange rate leads to a CZK 30 billion change in the koruna value of the CNB's reserves. Second, the income statement is affected (again in both directions) by income from foreign exchange reserves, i.e. interest on deposits, bonds, dividends on shares.
However, in recent years, especially since 2018, when inflationary developments forced the CNB to raise interest rates, its performance has been negatively affected by the cost of implementing monetary policy. The CNB does this by withdrawing bank liquidity at the cost of its two-week repo rate. This is no longer an accounting revaluation of the economic result, but a realised cost. In this case, the CNB has helped itself in the last two years by making its reserve requirement interest-free (from autumn 2023; similar to the ECB), which has been doubled to 4% from 2025 (without the ECB). This is partly compensated for by currency in circulation, i.e. cash, which, like the withdrawn liquidity on the CNB's liabilities side, is burdened with zero interest.
At present, the koruna does not appear to represent as significant a cost to the economic outcome in the medium term (given the fading convergence story) as the level of the neutral interest rate that the CNB will pay for withdrawn liquidity to the banking sector. And here again we return to the key problem of the Czech economy. The key question is how to increase the potential of the Czech economy. Its increase would then be reflected in softer inflationary pressures, a lower risk premium and, therefore, a lower CNB equilibrium interest rate at which the central bank withdraws excess liquidity from the banking sector.
2. The high reserves are not only a remnant of the foreign exchange interventions of 2013-2017, but also of the conversion of EU funds in the balance sheet of the CNB, which redistributed the subsequent effects in the economy.
Since 1998, there have been cumulative foreign exchange transactions by the CNB due to foreign exchange interventions of approximately €45 billion. However, if we add to the CNB's foreign exchange transactions client operations within the CNB's foreign exchange reserves (i.e. outside the market), where the main role is played by the conversion of EU fund transfers (see the 2008 memorandum for an explanation), including the current RRF, and earlier privatisation receipts (see the 2002 memorandum ), we arrive at EUR 46 billion. Since 2013, these accumulations have reached 45 billion and 35 billion euros respectively, while since 2018 (the CNB exited the exchange rate commitment, which was characterised by foreign currency purchases, in spring 2017), these accumulations have reached -30 billion euros in possibly foreign exchange interventions (which means foreign currency sales) vs. inflows of 21 billion euros in client operations.
To some extent, it can be concluded that the adopted mechanism of converting EU funds income within the CNB's foreign exchange reserves prevented a stronger appreciation of the koruna and was thus supportive for export activity and employment in these sectors. Although the conversion of EU funds under foreign exchange interventions prevented a stronger appreciation of the Czech koruna, it led to a stronger accumulation of foreign exchange reserves and the necessary volume of liquidity withdrawn by the banking sector. Thus, they are also the cause of the CNB's more significant losses.
3. If only it were like Poland; or a misplaced illustration of the central bank dividend: the size of transfers from the Polish central bank to the state budget averaged 0.22% of GDP per year between 2011 and 2023
This is a rather illustrative remark about the transfer to the state budget in a country where the central bank's income statement was not so strongly affected by the accumulation of foreign exchange reserves and the strong appreciation of the currency. The annual reports of the Polish central bank from 2011 to 2023 show transfers from the central bank to the Polish state budget in seven of the 13 years of the survey.
In the most recent years in which the transfer was made, i.e. 2019-2021, transfers amounted to between 7.4 and 10.4 billion Polish zloty, on average 0.36% of GDP. Over the whole period 2011-2023, transfers to the state budget (including years with zero transfer) amounted on average to 0.22% of Polish GDP. This is approximately CZK 17.5 billion in 2024 prices in the case of current Czech GDP.
4. Discussion over the level of the CNB's foreign exchange reserves and portfolio diversification - stocks in an infinite horizon?
The IMF has encouraged the CNB to reassess the level of foreign exchange reserves (see Article IV - 2024, paragraph 19, page 18) in light of the more than doubling of Czech foreign exchange reserves compared to the IMF's assessment of the adequacy of their level according to the IMF's ARA metric (see chart below left). There has also been occasional discussion of the possibility of using foreign exchange reserves more significantly to strengthen the Czech koruna to help dampen inflationary pressures.
If the volume of foreign exchange reserves were to be reduced more significantly, and if this operation were to be carried out against the CNB's investment portfolio of foreign exchange reserves (while preserving the nominal volume of the liquidity portfolio; see the CNB's overview here), this would (if the reduction in foreign exchange reserves were not carried out against the equity part of the investment portfolio) lead to an increase in the share of the equity part of the investment portfolio. This would potentially accelerate the move towards or beyond the target of a higher share of the equity portfolio in the investment tranche of the CNB's foreign exchange reserves. Implementation of the second option would imply (unless the targeted share of the equity component is increased again) a portfolio reallocation associated with the sale of equities. This is not fully consistent with one, though not the key, argument about the almost infinite holding horizon of the equity portfolio by the central bank. On the other hand, it should be noted that the strength of that argument weakens if we consider the higher share of gold in the foreign exchange reserve portfolio, which has dampened the volatility of equity indices in the past (for more details, see the CNB paper Balancing Volatility and Returns in the Czech Republic, 2023, see Figures 2b and 3b).