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Glaciers of Global Finance: The Currency Composition of Central Banks’ Reserve Holdings

The currencies that are being held by central banks as foreign exchange reserves have remained largely steady over decades.

Alina Iancu, Neil Meads, Martin Mühleisen, Yiqun Wu

December 16, 2020

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.

Financial links seem to be a key driver of reserve currency holdings.

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 reserve holdings

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 exchange market.

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 endure.

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:

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.

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