Journal of World Economic Research 2014; 3(6): 72-82 Published online November 17, 2014 (http://www.sciencepublishinggroup.com/j/jwer) doi: 10.11648/j.jwer.20140306.12 ISSN: 2328-773X (Print); ISSN: 2328-7748 (Online) An econometric analysis of the determinants of foreign exchange reserves in Bangladesh Md. Niaz Murshed Chowdhury 1 , Mohammed Jashim Uddin 2 Dr. Mohammad Saiful Islam 3 1 Research Assistant, Department of Economics, South Dakota State University, Brookings, USA 2 Lecturer, Department of Economics and Banking, International Islamic University Chittagong, Chittagong, Bangladesh 3 Associate Professor, Department of Economics, University of Chittagong, Chittagong, Bangladesh Email address: niaz060707@gmail.com (M. N. M. Chowdhury), grejasim@yahoo.com (M. J. Uddin), saifulcu@yahoo.com (M. S. Islam) To cite this article: Md. Niaz Murshed Chowdhury, Mohammed Jashim Uddin, Dr. Mohammad Saiful Islam. An Econometric Analysis of the Determinants of Foreign Exchange Reserves in Bangladesh. Journal of World Economic Research. Vol. 3, No. 6, 2014, pp. 72-82. doi: 10.11648/j.jwer.20140306.12 Abstract: This study undertakes an econometric analysis of the determinants of foreign exchange reserves. Yearly time series data have been used to figure out that type of relevant variables that are very much momentous for the determinants of foreign exchange reserves. This paper attempts to identify the key determinants of foreign exchange reserves in Bangladesh using Augmented Dicky Fuller (ADF) unit root test to examine the stationarity, Engle Granger residual based co-integration approach to show the co-integrating relationship among variables, and diagnostic tests for better modeling. The empirical results confirm that there exists a strong relationship among foreign exchange reserves, exchange rate, remittance, home interest rate, broad money (  ), UPI of export and import, and per capita GDP. The coefficients are found to change smoothly, as a function of seven threshold variables- out of nine candidates where six variables are statistically significant. Drawing inferences from these findings, it can be suggested that exchange rate, a strong remittance related policies, quality items of exports, and sustainable GDP can keep a substantial and feasible roles to make up a healthy amount of foreign exchange reserves for the host country like Bangladesh. Keywords: Co-Integration, ADF, Diagnostic Test, Imports, Broad Money and Foreign Exchange Reserves 1. Introduction The term of foreign exchange reserves refers to the supply of foreign currency currently being kept by the central bank of a special country. Alternatively known as forex reserves or FX reserves, this is comprised of a variety of international currencies but the US dollar is one of the most common currencies available in reserves of most countries. Foreign exchange reserves is defined by IMF in 2000 by this way “foreign reserves are defined as external stock of asset, which is available to the country’s monetary authorities to cover external payment imbalances or to influence the exchange rate of the domestic currencies through intervention in exchange market or for other purposes”. Historically under the Bretoon –Woods system, the foreign exchange reserves were used by the central bank across the world to maintain the external value of their respective currencies at a fixed level. With the break down of Bretoon – Woods system in the early 1970s, countries started adopting a relatively flexible exchange rate system, under which the reserves play only a less important role. Yet, the global exchange reserves have increased from 1.75 to 7.8 percent of world GDP between 1960 and 2002(Flood and Marion, 2002) Either from political or economic perspective a very sensitive indicator for any government is to maintain a satisfactory level of international reserve in its coffer. It is general notion that a country requires to have at least three months import bill but IMF suggest that reserve of the four months import bill is a prerequisite. So it is called that, if the amount of international reserve of the central bank below the country’s three months import bill, the situation is considered as critical. Generally, a country needs foreign exchange reserves mainly for two reasons, 1) to synchronize its receipt and payments with the rest of the world; and 2) to withstand occasional speculative raid by the dealers in the foreign exchange market. It somewhat resembles the household precautionary demand for cash balance. One of the main