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What is the Real Size of Macedonia's Foreign Exchange Reserves?

Sam Vaknin, Ph.D. - 6/13/2009

Here are the facts as they emerge from the periodical (mostly annual) reports of Macedonia's central bank, Narodna Banka na Republika Makedonija - NBRM, for short.

1. Towards the end of 2008, Macedonia's foreign exchange reserves amounted to c. 1.6 billion euros.

2. Macedonia's foreign exchange reserves were managed by its central bank.

3. NBRM invested about 75% of these foreign exchange reserves in government bonds, issued by countries such as the United States, Germany, United Kingdom, and other countries.

4. On October 24, 2008, I warned the NBRM publicly (for instance, via my column in Nova Makedonija) that government bonds are overvalued and their prices may collapse. I recommended to sell some of the government bonds and invest the resulting cash in bank deposits in banks in the West (which at the time yielded about 3% annually).

The Investment Committee of NBRM reacted, in a letter published by Nova Makedonija on October 30, 2008. They called my text "malicious" and "sensational" and accused me of "hiding the true situation ... leading to public confusion".

More to the point they said that they didn't care what the market prices of the bonds were because they do not intend to sell them. They have every intention of holding them to maturity and collecting from the issuers of the bonds (the various governments) the money they (NBRM) had invested plus the coupon (the interest payments on the bonds).

5. By end November 2008, some government bonds provided negative yield (if you bought them in the open market, you received less money on maturity than you had invested). This was a clear signal to sell. Bonds have never maintained negative yields for more than a few weeks. In other words, the market prices of bonds always collapsed after they reached negative yields.

6. Between December 2008 and early June 2009, the prices of government bonds fell between 7 and 17%, depending on the type of bond in question. On average, 10-year Treasury Notes (USA), Bunds (Germany), and Gilts (UK) fell by 8% (with some US Treasuries falling by 15% and more).

7. Had the NBRM sold the bonds it owned in November, it would have avoided a sizable loss on these bonds. The size of this loss is unknown because the NBRM provides very little data about its investments.

Theoretically, the NBRM said that it had 1.2 billion euros invested in bonds. A decline of even 7% in their market prices means a loss (some it realized, some of it unrealized, on the books) that could have been avoided of c. 90 million euros.

The NBRM does not inform the public what is the market value of its investments (as opposed to the theoretical value of the bonds if they are held to maturity).

8. NBRM got it wrong not only regarding the prices of government bonds, but also regarding whether it would need to sell a meaningful chunk of its bond portfolio on short order. As you recall, the NBRM insisted that there would be no need to sell the bonds until they reach maturity.

The NBRM was wrong. Between December 2008 and May 2009 the NBRM sold more than 300 million euros in a misguided attempt to keep the exchange rate of the Macedonian denar fixed against the euro. Assuming that 75% of this amount was invested in bonds, it would seem that NBRM was forced to sell more than 200 million euros in bonds, in the open markets, at the new, much reduced prices - exactly the scenario that I had predicted.

9. Finally, from around February 2009, the consensus of experts and large government bond portfolio managers around the world is that bond prices will continue to fall, possibly precipitously. If NBRM has changed its policy of investing in government bonds it has yet to inform the public.

NBRM should sell as much of its bond portfolio as it can before it suffers catastrophic losses. In the past 60 years, bond markets have collapsed at least three times, with the market prices of bonds falling by more than 35%.