A recent report from the International Monetary Fund (IMF) has brought attention to a significant trend in global reserve currencies, signalling a departure from the longstanding dominance of the US dollar.
Namely, the IMF’s Currency Composition of Official Foreign Exchange Reserves (COFER) data has revealed a consistent decline in the US dollar’s share of allocated foreign reserves over the past two decades. This is despite the fact that the strength of the US economy, coupled with tighter monetary policies and heightened geopolitical risks, has led to a higher valuation of the US dollar.
“This recent trend is all the more striking given the dollar’s strength, which indicates that private investors have moved into dollar-denominated asset,” the IMF said in a blog post last week.
What’s noteworthy is that the dollar’s decline has not been balanced by increases in the shares of other major currencies such as the euro, yen, and pound, instead there has been a significant rise in the allocation of what it considers “nontraditional” reserve currencies. These include the Australian dollar, Canadian dollar, Chinese renminbi, South Korean won, Singaporean dollar, and the Nordic currencies.
“These nontraditional reserve currencies are attractive to reserve managers because they provide diversification and relatively attractive yields, and because they have become increasingly easy to buy, sell and hold with the development of new digital financial technologies (such as automatic market-making and automated liquidity management systems),” the IMF elaborated.
The fund explained that statistical tests do not show a rapid decline in the dollar’s reserve share, challenging claims of accelerated movement due to US financial sanctions, although some argue that countries shifting from dollars may not report to COFER, the IMF said non-reporters constitute a small share of global reserves.
One nontraditional reserve currency gaining market share is the Chinese renminbi, whose gains match a quarter of the decline in the dollar’s share.
“The Chinese government has been advancing policies on multiple fronts to promote renminbi internationalisation, including the development of a cross-border payment system, the extension of swap lines, and piloting a central bank digital currency,” the IMF outlined.
However, recent data suggests a levelling off in its reserve share, possibly influenced by exchange rate fluctuations and geopolitical considerations.
“The most recent data do not show a further increase in the renminbi’s currency share: some observers may suspect that depreciation of the renminbi exchange rate in recent quarters has disguised increases in renminbi reserve holdings. However, even adjusting for exchange rate changes confirms that the renminbi share of reserves has declined since 2022.”
Examining other potential reasons for the ongoing decline in dollar holdings, the IMF noted that some argue this trend is primarily driven by a few but influential reserve holders.
For instance, Russia is cautious about holding dollars due to geopolitical reasons, while Switzerland, having accumulated reserves over the past decade, has a strategic interest in holding a substantial portion of its reserves in euros, given its proximity to the euro area and significant trading partnership with the region.
“But when we exclude Russia and Switzerland from the COFER aggregate, using data published by their central banks from 2007 to 2021, we find little change in the overall trend,” the IMF said, adding that the shift is broad-based.
The IMF also looked into gold as a potential factor driving the shift from the US dollar, but found that while financial sanctions historically prompted minor adjustments in reserve portfolios towards gold, its share remains historically low despite increased appeal due to economic uncertainty and geopolitical risks.
Ultimately, the IMF underscored that the international monetary and reserve system is undergoing continuous evolution.
“The patterns we highlighted earlier – very gradual movement away from dollar dominance, and a rising role for the nontraditional currencies of small, open, well-managed economies, enabled by new digital trading technologies – remain intact.”
