The strength and well-being of an economy cannot be measured by how much foreign reserves it holds, Monetary Authority Chief Executive Joseph Yam says.

In his latest Viewpoint column published today, Mr Yam said Hong Kong has seen a drop in its ranking among holders of official foreign reserves in recent years, from the third highest in the world in 1997 to the eighth now.

"Some people seem to be disappointed about us having been overtaken by other economies. This is perhaps understandable since, rightly or wrongly, the amount of foreign reserves is often seen as a measure of financial strength or perhaps even the well-being of an economy," he writes.

"As you would expect, my response is that this is not necessarily the case."

Mr Yam pointed out the financial robustness of an economy cannot be measured by the amount of foreign reserves it holds.

"The Mainland now tops the ranking, with over US$875 billion in foreign reserves, but there is still considerable room for improvement in its financial system," he said.

"The abundance of foreign reserves certainly makes things easier: indeed, large amounts have been used to recapitalise the state-owned banks. It also strengthens the ability of individual jurisdictions to deal with a financial crisis."

Financial crisis underlined need for reserves as ammunition

He said the Asian financial crisis has underlined the strategic need to build up foreign reserves as ammunition for possible - and perhaps, in these days of globalisation, probable - battles in the fight for monetary and financial stability.

"The way we defended ourselves during 1997-98 supported this view. But financial robustness is founded upon prudent macroeconomic policies, strong institutions and systems, and many other factors.

"The fact that the developed economies in Europe and North America are all down the list - some of them way down - illustrates this quite clearly, although the macroeconomic policies of some are not exactly unquestionable."

Foreign reserve build-up not necessarily positive

He said the build-up of official foreign reserves is not necessarily a good thing, despite the comfort of having more ammunition in the monetary armoury.

"Corresponding to the foreign reserves on the asset side of the balance sheet of the central bank, there are liabilities in the domestic currency, typically in the form of a large monetary base, or more precisely a large aggregate balance of the banks from which the foreign reserves were bought.