Thursday, December 17, 2020 /06:59
AM / By Alina Iancu, Neil Meads, Martin Muhleisen, Yiqun Wu, IMFBlog
/ Header Image Credit: (Photo: Gomezdavid/Istock By Getty Images)
currencies that are being held by central banks as foreign exchange reserves
have remained largely steady over decades. Changes in the composition of
these holdings can, at best, be described as glacial in pace. But geopolitical
shifts and technological revolutions are reshaping the global economy and the
international use of currencies. These forces, and the fallout from the
COVID-19 pandemic, could further accelerate the transformations in the reserve
holdings of central banks.
The status quo
There are currently around 180 national currencies,
but only a few are widely used for international transactions, such as
invoicing, paying for imports, and issuing debt or investing abroad. These
currencies are the U.S. dollar, the euro, and, to a lesser extent, the Japanese
yen, the British pound, and a few others. When crises hit, companies and
investors usually seek safety in dollars.
Central banks have long held international reserves in
these same currencies. This is unsurprising as reserves are intended to back up
international transactions as described above, allowing country authorities to
finance balance of payments needs, intervene in foreign exchange markets, and
provide foreign exchange to domestic agents.
The slow pace of change in
Building on a novel dataset, a new IMF staff paper analyzes the
composition and drivers of central banks' reserve currency holdings over recent
decades, and how these drivers have changed.
One key finding is that, given the dollar's (and to
some extent, the euro's) international dominance, to date, any shifts in
central bank reserve holdings have been minimal.
For example, despite China's growing role in the
global economy, the Chinese renminbi has gained only a small foothold in global
transactions, such as issuing foreign debt or trading in the global foreign
The paper also found that financial links seem to be a
key driver of reserve currency holdings, and increasingly so in the last
decade. This would suggest that, as long as the dollar continues to dominate
global finance and trade, its dominance as a reserve currency looks set to
But, just as slow-moving glaciers can sometimes
unexpectedly surge forward, the currency composition of reserve holdings has
the potential to undergo a sudden, unexpected, and accelerated transformation.
The future of reserve currencies
Our paper suggests a number of economic and financial
trends that could impact the future composition of reserve holdings.
Geopolitical and technological developments might prove as significant as
economic considerations, and, together with the current COVID-19 pandemic,
could accelerate future transformations. Potential drivers of change include:
- 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 also issue more debt in the currencies of emerging creditors, such as
China, to help meet increased financing needs. Our paper finds that the
currency denomination of public debt is an especially important determinant of
emerging market and developing countries' reserve holdings, likely reflecting
central banks' desire to hedge against risks associated with debt obligations.
- Changing trade
links and invoicing practices could also alter demand
for international currencies. Both the pandemic and recent trade tensions
have highlighted the fragility of global supply chains. Countries are now
more interested than ever in ensuring critical supplies. A shift toward
localized production would reduce the demand for international currencies.
- Meanwhile, 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
- The credibility of
the policies of debt-issuing countries is fundamental for trust in their
currencies. The COVID-19 pandemic has highlighted the need for current and
potential issuers to enact sound health and economic policies to preserve
their growth potential.
- The international use of
currencies can also reflect strategic considerations.
For instance, reserve currency portfolio decisions may be influenced by
foreign policy considerations and security ties. The fallout from trade
tensions and international sanctions can prompt countries to consider
changes in their reserve holdings and potential issuers to seek to
internationalize their currencies.
- 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 the issuance of central bank digital currencies
which could increase demand for their currencies.
- Superior technology platforms could also
help new currencies overcome some of the 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
There is currently no sign of major shifts in the
composition of central bank reserve currencies. However, the glacial pace of
change over recent decades should not be taken as an indication of the future.
There is considerable uncertainty around global economic and financial trends,
as well as geopolitical and technological developments, and so scope for more
dynamic transformation in the future.
Reserves: CBN May Reduce Euro Holdings
2. CBN Mulls Holding
Reserves in Yuan
What to do When Low-for-Long Interest Rates are Lower and
World Bank Group to Boost Nigeria's Efforts to Reduce
IMF Staff Completes 2020 Article IV Mission to Nigeria
Open Trade and Economic Inclusion Key to Post-COVID
5. AfDB's AgriPitch Competition Awards $120,000 in Prizes to
African Youth Agripreneurs
Bridging the Digital Divide to Scale Up the COVID-19
7. AfDB, AIF Founding Partners Announce Postponement of the
Africa Investment Forum to 2021
Remittance Flows to Shrink 14% by 2021 Due to COVID-19
How COVID-19 Will Increase Inequality in Emerging Markets
and Developing Economies
10. SSA October 2020 Regional Economic Outlook: A Difficult
Road to Recovery
Communique of the 42nd Meeting of the IMFC Chaired by Mr.
12. WEO: A Long and Difficult Ascent - Global Growth
Projected at -4.4% in 2020
13. IMF Executive Board Approves the Extension of Increased
Access Limits Under the RCF and RFI
14. IMF Extends Immediate Debt Service Relief for 28 Eligible
Low-Income Countries for 6-months
15. Reform of the International Debt Architecture is Urgently
16. African Development Bank Named to the Board of World
Business Angels Investment Forum
COVID-19's Negative Impact on Health and Education May
18. Opening Remarks at the 2020 International Conference on
19. World Bank Sets Ambitious Targets for Green and Resilient
Economic Growth in Africa
20. Supporting Migrants and Remittances as COVID-19 Rages On