The dollar continues to lose ground to non-traditional currencies in global foreign exchange reserves, but it remains the most important reserve currency.
The dollar has appreciated on the back of strong US economic performance, tighter monetary policy and heightened geopolitical risks; Against this backdrop, the dominance of the dollar – its outsized role in the world economy – has come into focus again recently. At the same time, the fragmentation of the global economy and the possible restructuring of global economic and financial activities into separate, non-overlapping blocs may encourage some countries to use and hold other international and reserve currencies.
The latest data from the IMF’s Database on the Composition of Currencies in Official Foreign Exchange Reserves (COFER) show that the dollar’s share in central bank and government reserve allocations is gradually declining. Remarkably, while the dollar’s role has diminished over the past two decades, the share of the other three of the “Big Four” currencies – the euro, the yen, and the pound – has not risen commensurately. Instead, it has been accompanied by a rise in the proportion of what we call “non-traditional reserve currencies”, including the Australian dollar, Canadian dollar, Chinese yuan, Korean won, Singapore dollar and Nordic currencies. We noted this trend in an IMF paper and blog, and the latest data suggest it is continuing.
These non-traditional reserve currencies are attractive to reserve managers because they offer diversification opportunities and relatively attractive yields; And, with the development of new digital financial technologies, such as automated market making and automated liquidity management systems, these currencies are also becoming easier to trade and hold.
This recent trend is all the more remarkable given the strong dollar, which suggests that private investors have shifted to dollar-denominated assets. This can also be seen in changes in relative prices. It is also a reminder that exchange rate fluctuations can have an independent impact on the currency composition of a central bank’s reserve portfolio. Changes in the relative value of different government securities, which are reflected in changes in their interest rates, can also have an impact, although this effect tends to be smaller, as bond yields in major currencies generally move in a consistent fashion. In any case, these valuation effects reinforce the overall trend. But over the longer term, the value of the dollar has remained largely unchanged while its share of global reserves has declined, suggesting that central banks are indeed gradually reducing their dollar holdings.
At the same time, statistical tests do not show an accelerated decline in the share of dollar reserves, contrary to the argument that US financial sanctions have led to an accelerated abandonment of the dollar. To be sure, as some have pointed out, countries seeking to ditch the dollar for geopolitical reasons may not be reporting information on the composition of their reserve portfolios to COFER. It should be noted, however, that the 149 economies reporting to COFER account for 93% of global foreign exchange reserves. In other words, unreported economies account for only a small fraction of global reserves.
Among the non-traditional reserve currencies that have gained market share is the renminbi, whose share has risen by a quarter of the dollar’s decline. The Chinese government has been promoting the internationalization of the renminbi in various aspects, including the development of cross-border payment systems, the expansion of swap arrangements, and the trial of the central bank digital currency. So it is interesting that the internationalisation of the renminbi is showing signs of stalling, at least in terms of the proportion of renminbi in countries’ reserves. The latest figures do not show a further increase in the share of renminbi in reserve currencies: some observers may suspect that the depreciation of the renminbi in recent quarters has masked the increase in reserves. However, even adjusting for changes in exchange rates, the yuan’s share of reserves has fallen since 2022.
Some argue that what we call the “continued decline in dollar holdings” and the “rise in the share of reserves in non-traditional currencies” actually reflect the behavior of a few large reserve holders. Russia has geopolitical reasons to be cautious about holding dollars; Switzerland has built up its reserves over the past decade, and it makes sense to hold most of them in euros, given its geographical proximity to the eurozone, which is its most important trading partner. But when we remove the data for Russia and Switzerland from COFER’s aggregated data (using data published by the two central banks from 2007 to 2021), we find little change in the overall trend.
In fact, this trend is quite common. In a 2022 report, we identified 46 “proactive reserve diversification countries,” defined as those with at least 5 percent of their reserves in non-traditional currencies by the end of 2020. These countries include major advanced and emerging economies, including most of the G20 economies. By 2023, at least three more countries (Israel, the Netherlands, Seychelles) will make the list.
We also find that financial sanctions imposed in the past have prompted central banks to shift their reserve portfolios slightly from currencies to gold – currencies are at risk of being frozen and redeployed, while gold can be stored domestically and thus protected from sanctions risk. The study also shows that central bank demand for gold responds positively to global economic policy uncertainty and global geopolitical risks. These factors may be the reason for some emerging market central banks to accumulate gold further. But before reading too much into this trend, it is important to remember that gold’s share of reserves remains historically low.
In short, the international monetary and reserve system is constantly changing. The pattern we highlighted earlier – namely, the very slow retreat of the dollar from dominance and the rising role of non-traditional currencies in small, well-managed open economies, supported by new digital transaction technologies – continues.