This year, central bank reserve management will be shaped by three Ds: de-dollarisation, diversification and deployment. How these trends play out could have an important bearing on currency and asset markets.
De-dollarisation
The topic of de-dollarisation has grabbed the headlines over the past year. One group seemingly keen to reduce its reliance on the greenback is the newly expanded Brics bloc. Egypt, Ethiopia, Iran, the United Arab Emirates and Saudi Arabia joined Brazil, Russia, India, China and South Africa on 1 January (Argentina declined to focus on efforts closer to home). Their reported plan for a common Brics currency would presumably reduce the need for central banks in these major emerging economies to hold dollars.
In reality, it’s unlikely that a Brics currency would pose a major threat to the dollar. But these countries allying adds to the sense that geopolitics will become an increasingly important factor in reserve management. The weaponisation of finance, following western sanctions on Russian reserves, could also prompt central banks outside the western political sphere to become more wary of their dollar holdings.
OMFIF’s Global Public Investor 2023 report found some evidence for the ‘friendshoring’ of reserves. This report was based on a survey of 75 central bank reserve managers with close to $5tn in reserves. We found that the central banks in Sub-Saharan Africa and Asia Pacific – which have relatively close economic and political ties to China – were most likely to indicate a shift away from dollar holdings in favour of renminbi over the next 10 years.
This shift is expected to be slow and gradual. On average, respondents expected that the dollar’s share of global reserves will fall by 5 percentage points over the next decade, but remain dominant at above 50%. Meanwhile, they predicted that the renminbi will rise to 6% of global reserves in this time, from just under 3% now (Figure 1).
Figure 1. Central banks expect slow pace of de-dollarisation
Historical and predicted shares of dollar and renminbi in global reserves, %
Source: OMFIF GPI 2023
Accordingly, it’s not so much de-dollarisation but gradual diversification of currency holdings that is the focus of most central banks. For the 2024 GPI report, we’ll examine whether reserve managers’ sentiment towards the dollar has soured as the global economy continues to fracture along geopolitical lines.
Diversification
The GPI 2023 report also showed that traditional reserve assets – bonds and gold – were most in demand. A net 32% of respondents expected to add to their conventional government bond holdings in the next 12-24 months and a net 14% to gold (Figure 2).
This was indicative of a flight to safety during turbulent market conditions (our survey was conducted in March during the volatility sparked by the collapse of Silicon Valley Bank and Credit Suisse). It also suggested that reserve managers were being lured into fixed income products that offered more attractive yields than for most of the past decade.
Figure 2. Traditional reserve assets in demand
Over the next 12-24 months do you expect to increase, reduce or maintain your allocation to the following assets classes? Share of respondents, %
Source: OMFIF GPI 2023
The latest data from World Gold Council suggest that the shift towards bullion has played out. Up to the third quarter of 2023, year-to-date central bank gold purchases were 14% higher than the year before with central banks in China, Poland and Singapore among the biggest buyers.
A key question for 2024 is whether reserve managers will continue to seek safety in traditional reserve assets, such as government bonds and gold, or if plans to diversify towards new and riskier asset classes such as equities and corporate bonds will restart in the months ahead. A more stable global macroeconomic environment would presumably be needed to reignite the risk appetite of reserve managers.
Otherwise, sustainable assets may offer opportunities for reserve managers to diversify. Environmental, social and governance integration is one area where reserve managers clearly lag compared to public pension and sovereign funds. While over 40% of survey respondents last year planned to increase their allocation to green bonds, most of that share came from European central banks. As transition finance becomes an increasingly important factor in global markets, central banks outside of Europe may start to seriously consider adding to their sustainable asset holdings.
Deployment
The broad-based strengthening of the dollar in the past two years has prompted many central banks to deploy their foreign exchange reserves to defend their currencies. We estimate that this, alongside adverse valuation effects, has caused the value of global international reserve assets to drop to under $15tn by the end of 2023, from a peak of $15.6tn in December 2021 (Figure 3).
Figure 3. Stalled growth in global reserves
Global international reserve assets, OMFIF estimate, $tn
Source: London Stock Exchange Group, International Monetary Fund, national central banks, OMFIF analysis
In some cases, central banks may have gone too far to prop up their currencies. The International Monetary Fund’s Article IV publication for India, published last month, stated ‘During December 2022-October 2023, the Rupee-U.S. Dollar exchange rate moved within a very narrow range, suggesting that [foreign exchange intervention] likely exceeded levels necessary to address disorderly market conditions’. In a similar vein, Eli Remolona, Bankgo Sentral ng Pilipinas governor, has stated the central bank has intervened too much in foreign exchange markets.
Overall, the focus of many central banks this year will probably be to rebuild rather than deploy their foreign exchange reserves. The value of the dollar may not drastically change in 2024, which could give central banks some breathing room to replenish their international assets. However, it would mean little reprieve for vulnerable countries with already-depleted reserves, with Ethiopia becoming the latest sovereign to default on international obligations.
Nikhil Sanghani is Managing Director, Economic and Monetary Policy Institute, OMFIF.
These themes will be further explored at OMFIF’s Global Public Investor seminar on 26 March. Register to attend here.