Glaciers of Global Finance: The Currency Composition of Central Banks’ Reserve Holdings
IMF Blog, December 16, 2020
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Bibliographic details
- Authors: Alina Iancu, Neil Meads, Martin Mhleisen, Yiqun Wu
- Published: December 16, 2020
Overview and context
- Authors: Alina Iancu, Neil Meads, Martin Mühleisen, Yiqun Wu
- Date: December 16, 2020
- Core message: The currencies held by central banks as foreign exchange reserves have remained largely steady over decades, but geopolitical shifts, technological revolutions, and the COVID-19 pandemic could accelerate future transformations.
Current status of reserve currencies
- There are currently around 180 national currencies, but only a few are widely used for international transactions (invoicing, paying for imports, issuing debt, investing abroad): the U.S. dollar, the euro, and, to a lesser extent, the Japanese yen, the British pound, and a few others.
- In crises, companies and investors usually seek safety in dollars.
- Central banks have long held international reserves in these same currencies to finance balance of payments needs, intervene in foreign exchange markets, and provide foreign exchange to domestic agents.
Key empirical findings
- Building on a novel dataset, the IMF staff paper analyzes composition and drivers of central banks’ reserve currency holdings over recent decades.
- Any shifts in central bank reserve holdings have been minimal to date, given the dollar’s (and to some extent, the euro’s) international dominance.
- Despite China’s growing role in the global economy, the Chinese renminbi has gained only a small foothold in global transactions (issuing foreign debt, trading in the global foreign exchange market).
- Financial links appear to be a key driver of reserve currency holdings, and have become increasingly important in the last decade.
- The currency denomination of public debt is an especially important determinant of emerging market and developing countries’ reserve holdings, reflecting central banks’ desire to hedge against risks associated with debt obligations.
Potential drivers of future change (scenarios and mechanisms)
- Shifts in international finance:
- The strong response to the European Commission’s large-scale bond issuance in October highlights potential demand for alternatives to dollar-denominated debt.
- Emerging market and developing countries could issue more debt in the currencies of emerging creditors, such as China, to meet increased financing needs.
- Trade links and invoicing practices:
- The pandemic and recent trade tensions have highlighted the fragility of global supply chains, prompting interest in ensuring critical supplies and potentially a shift toward localized production that would reduce demand for international currencies.
- Lower reliance on any single trading partner might diversify demand for currencies.
- The recent conclusion of the Regional Comprehensive Economic Partnership in Asia — a free trade agreement between fifteen nation states in the region — may signify a larger role for alternate currencies that currently account for a small share in international reserves.
- Credibility and policy fundamentals:
- The credibility of policies of debt-issuing countries is fundamental for trust in their currencies; the COVID-19 pandemic has highlighted the need for sound health and economic policies to preserve growth potential.
- Strategic and geopolitical considerations:
- International use of currencies can reflect foreign policy considerations and security ties.
- Trade tensions and international sanctions can prompt changes in reserve holdings and motivate potential issuers to seek to internationalize their currencies.
- Technological change and digital money:
- The pandemic has accelerated advances in financial and payment technologies.
- Potential competition from private issuers such as Diem — Facebook’s blockchain-based payment system — has spurred major central banks to accelerate work on central bank digital currencies and cross-border payments.
- The European Central Bank and People’s Bank of China, among others, are exploring issuance of central bank digital currencies which could increase demand for their currencies.
- Superior technology platforms could help new currencies overcome some advantages of incumbent currencies; depending on the adoption and use of public or private digital money, central banks might have to rethink what constitutes, and how to hold, reserves going forward.
Implications and conclusions
- There is currently no sign of major shifts in the composition of central bank reserve currencies.
- The historical glacial pace of change should not be taken as an indication of the future; there is considerable uncertainty around global economic and financial trends, geopolitical developments, technological innovation, and the impact of the COVID-19 pandemic, leaving scope for more dynamic transformation ahead.
IMF staff blog: Glaciers of Global Finance: The Currency Composition of Central Banks’ Reserve Holdings