Import Cover

Import cover is the number of months that a country could continue to pay for its imports of goods and services using only its existing foreign exchange reserves, assuming no new foreign currency came in from exports, remittances, investment or borrowing. It is the oldest and simplest measure of how long an economy could withstand an external shock, and it is widely reported by central banks, finance ministries, rating agencies and the International Monetary Fund.

A country with low import cover is vulnerable to any interruption in its foreign currency inflows. If export revenue falls or lenders stop rolling over debt, it may quickly be unable to pay for food, fuel and medicine priced in hard currency.

The basic formula is:

Import cover (months) = Usable reserves / (Annual imports of goods and services / 12)

Reserves are normally the gross official reserves held by the central bank: foreign currency deposits and securities, monetary gold, Special Drawing Rights and the reserve position at the IMF. Analysts often adjust the figure, because some reserves may be pledged, borrowed through swaps or otherwise unavailable. Imports may be measured over the previous twelve months or projected for the coming year; using projected imports is more forward-looking.

A country holds US$12 billion in usable reserves. Its imports of goods and services over the past year were US$48 billion, or US$4 billion a month. Import cover is 12 / 4 = 3 months. If a drop in commodity prices cut export earnings and the central bank spent US$4 billion defending the currency, reserves would fall to US$8 billion and import cover to 2 months, a level that would usually alarm investors and rating agencies.

A long-standing rule of thumb holds that reserves should cover at least three months of imports. The benchmark dates from a period when capital flows were limited and most foreign currency demand came from trade. Countries with a fixed exchange rate, a currency board or volatile commodity exports are generally expected to hold considerably more.

Import cover captures only one source of pressure on reserves. With open capital accounts, a country can lose reserves much faster through capital flight, maturing foreign debt or withdrawals of foreign investment than through paying for imports. For that reason, economists use other measures of reserve adequacy alongside import cover:

• The Greenspan–Guidotti rule, which compares reserves with external debt falling due within one year and suggests reserves should at least match it.
• Reserves to broad money, which indicates how much domestic money could be converted into foreign currency in a crisis of confidence.
• The IMF's composite reserve adequacy metric, which combines exports, short-term debt, other liabilities and broad money with weights that depend on the exchange rate regime.

Import cover also ignores the fact that imports usually fall sharply in a crisis, as a weaker currency and tighter financing reduce demand, so the measure can overstate how quickly reserves would actually run out.

When import cover falls, governments often respond with measures that directly affect trade and payment flows. These include rationing foreign currency through banks, requiring letters of credit or cash margins for imports, delaying payment approvals, imposing capital controls, tightening export proceeds repatriation rules, and seeking emergency funding through IMF programs or a central bank swap line. For importers, payment providers and remittance companies, falling import cover is an early warning that obtaining dollars in that market may become slower and more expensive, and that a parallel market rate may open up.

Import cover is closely watched alongside the current account balance and the balance of payments. A persistent current account deficit financed by short-term inflows tends to show up first as declining import cover.