Global finance, political business cycles, and the politics of foreign reserves

Foreign reserves provide developing countries with resources for managing the effects of economic shocks and crises. Why do reserve levels vary across the developing world? Political business cycles (PBCs) have been associated with reserve level decreases, as incumbents draw them down to fund policies that provide voters with material benefits before elections. But governments can also obtain capital by borrowing on bond markets, getting the resources needed to fund PBC policy efforts through alternative means. We hypothesize and find that this means global finance conditions the PBC effect on foreign reserve levels. When pre-election global interest rates are high and borrowing is expensive, governments do draw down reserves. But when pre-election global interest rates are low and borrowing is cheap, governments borrow rather than deplete reserves. This helps explain variation in reserve levels, and thus variation in resilience against economic shocks, across developing countries. The study further suggests the importance of accounting for reserve use in studies of PBC effects on debt, adds novel PBC identification strategies to the literature, and signals how the politics of diverse areas of economic policymaking can be affected by global financial conditions.