The decade-long surge in foreign-currency reserves held by the world’s central banks is coming to an end.
Global reserves declined to $11.6tn in March from a record $12.03tn in August 2014, halting a five-fold increase that began in 2004, according to data compiled by Bloomberg. While the drop may be overstated because the strengthening dollar reduced the value of other reserve currencies such as the euro, it still underlines a shift after central banks – with most of them located in developing nations like China and Russia – added an average $824bn to reserves each year over the past decade.
Beyond being emblematic of the dollar’s return to its role as the world’s undisputed dominant currency, the drop in reserves has several potential implications for global markets. It could make it harder for emerging-market countries to boost their money supply and shore up faltering economic growth; it could add to declines in the euro; and it could damp demand for US Treasury bonds.
“It’s a big challenge for emerging markets,” Stephen Jen, a former International Monetary Fund economist who’s co-founder of SLJ Macro Partners in London, said by phone. They “now need more stimulus. The seed has been sowed for future volatility,” he said.
Stripping out the effect from foreign-exchange fluctuations, Credit Suisse Group AG estimates that developing countries, which hold about two-thirds of global reserves, spent a net $54bn of this stash in the fourth quarter, the most since the global financial crisis in 2008.
China, the world’s largest reserve holder, together with commodity producers contributed to most of the declines, as central banks sold dollars to offset capital outflows and shore up their currencies. A Bloomberg gauge of emerging-market currencies has lost 15% against the dollar over the past year.
China cut its stockpile to $3.8tn in December from a peak of $4tn in June, central bank data show. Russia’s supply tumbled 25% over the past year to $361bn in March, while Saudi Arabia, the third-largest holder after China and Japan, has burned through $10bn in reserves since August to $721bn.
The trend is likely to continue as oil prices stay low and growth in emerging markets remains weak, reducing the dollar inflows that central banks used to build reserves, according to Deutsche Bank AG.
Such a development is detrimental to the euro, which had benefited from purchases in recent years by central banks seeking to diversify their reserves, according to George Saravelos, co-head of foreign-exchange research at Deutsche Bank.
The euro’s share of global reserves dropped to 22% in 2014, the lowest since 2002, while the dollar’s rose to a five-year high of 63%, the International Monetary Fund reported on March 31.
“The Middle East and China stand out as two regions that are likely to face ongoing pressures to run down reserves over the next few years,” Saravelos wrote in a note. The central banks there “need to sell euros,” he said.
The euro has declined against 29 of 31 major currencies this year as the European Central Bank stepped up monetary stimulus to avert deflation. The currency tumbled to a 12-year low of $1.0458 on March 16, before rebounding to $1.0990 at 8:14 am yesterday in New York.
Central banks in emerging nations started to build up reserves in the wake of the Asian financial crisis in the late 1990s to safeguard their markets for periods when access to foreign capital dries up. They also bought dollars to limit appreciation in their own exchange rates, quadrupling reserves from 2003 and boosting their holdings of US Treasuries to $4.1tn from $934bn, data compiled by Bloomberg show.
The reserve accumulation adds money supply to the financial system – each dollar purchase creates a corresponding amount of new local currency – and helps stimulate the economy. Annual monetary base in China and Russia grew at an average 17% in the decade through 2013, data compiled by Bloomberg show. The expansion rate tumbled to 6% last year.
While central banks have other ways of pumping cash into the banking system, such moves without the backing of increased foreign reserves could end up weakening their currencies further – an outcome they may want to avoid.
“The swing in global foreign exchange reserves is one key measure of the global liquidity tap being turned on and off,” Albert Edwards, a global strategist at Societe Generale SA, wrote in a note on March 6. “When a regime of loose money suddenly ends,” emerging-market asset prices “are usually one of the first casualties,” he said.