Optimum international reserves and sovereign risk: Evidence from India

This paper empirically determines the optimal level of international reserves for India by explicitly incorporating the country's sovereign risk associated with the default on external debt. The optimum level of reserves is determined by minimizing the central bank's cost function, which consists of costs due to high reserve holdings and costs due to reserve depletion. The simulated optimum reserves for the period 1994-2010 indicate that actual reserves are higher than the optimum value across the sample period, except during 1997-1998.