Dollar’s share of global reserves falls to 25-year low

The US dollar’s share of international reserves portfolios reached its lowest level in 25 years in 2020’s fourth quarter, according to International Monetary Fund figures.

The IMF said dollar-denominated assets constituted 59% of global reserves portfolios at the end of 2020, according to its Currency Composition of Official Foreign Exchange Reserves survey. The world’s dominant reserve currency experienced a slight decline from the 60.7% share it recorded in December 2019, according to the report, published on May 6.

“Some analysts say this partly reflects the declining role of the US dollar in the global economy, in the face of competition from other currencies used by central banks for international transactions,” say the authors Serkan Arslanalp and Chima Simpson-Bell.

They point out this is another step in a long-term trend initiated over two decades ago. “The share of US dollar assets in central bank reserves dropped by 12 percentage points – from 71% to 59% – since the euro was launched in 1999,” the authors say.

The euro, the second most-used reserve currency, rose from 20.6% of total reserves at the end of 2019 to 21.2% a year later.

But despite the rise of the euro since its creation in 1999, the authors stress the dollar remains the world’s dominant reserve currency.

Last year data from Central Banking Institute’s Benchmarking Service indicated the international role of the euro is largely regional. The currency is mostly used in cross-border invoicing within the eurozone and as a reserve currency for European central banks.

Eurozone sovereign debt assets accounted for 20.7% of total foreign exchange reserves for European banks, according to the Central Banking Institute’s Reserve Benchmarks for 2020. But euro sovereign debt accounted for just 4.1% of reserves of non-European central banks, according to that data.

By contrast, US Treasuries represented 35% of non-European reserves. Even in Europe they accounted for 27% of portfolios, considerably more than euro sovereign bonds.

Currency diversification effect

Rather than the euro, a set of currencies with much lower shares in reserves portfolios have greater potential for growth, many central bank reserve managers say. These include the Australian dollar, Canadian dollar and yuan, whose combined share climbed to 9% of total reserves at the end of 2020.

The IMF added the yuan in October 2016 to the basket of currencies it uses to calculate the value of its Special Drawing Rights (SDR) with a weighting of 10.92%. The dollar has a 41.73% weighting and the euro 30.93%. Following this move, some observers expected the yuan would be much more widely adopted in reserves portfolios.

However, this process has been very slow. The yuan closed 2020 slightly over 2.2% of global portfolios, up from 1.9% a year earlier.

“During periods of US dollar weakness against major currencies, the US dollar’s share of global reserves generally declines since the US dollar value of reserves denominated in other currencies increases (and vice versa in times of US dollar strength),” say Arslanalp and Simpson-Bell. Nonetheless, although they see that the dollar’s share in reserves is broadly steady, there are signs pointing to a gradual shift away from it.

“The fact that the value of the US dollar has been broadly unchanged, while the US dollar’s share of global reserves has declined, indicates that central banks have indeed been shifting gradually away from the US dollar,” say the authors.

One main example of this shift has been Russia. Since October 2012 the country has drastically reduced its US Treasury holdings, the main asset central banks use to access dollars, from over $171 billion to just $5.7 billion in February 2021.

Russia’s shift away from the dollar is not primarily based on financial and economic fundamentals. In the wake of its invasion of eastern Ukraine in early 2014 and financial sanctions from the US, Vladimir Putin’s regime started to reduce Russia’s exposure to the dollar in a bid to limit the potential impact of this sanctions in the future.

The authors add, however, that some observers expect that the dollar “will continue to fall as emerging market and developing economy central banks seek further diversification of the currency composition of their reserves”.