Trends in International Reserves, China Aside

The International Monetary Fund's (IMF) Currency Composition of Official Foreign Exchange Reserves (COFER) database, released quarterly, is critical to shedding light on the state of the global economy. The latest release shows that while the dollar continues to be an important reserve currency, reserves are also diversifying towards nontraditional currencies. What's more, the addition of the renminbi to the basket that values the IMF's special drawing right (SDR) at the end of November injects new life into the latter trend. The dollar's value share¹ (the shares of each currency valued in US dollars divided by the total of all currencies in US dollars) has risen because of its appreciation, particularly since mid-2014, while its quantity share² (value shares adjusted for exchange rate changes) has declined amid dollar selling by both developing and advanced economies.³ The euro's value share has similarly declined, but both its value and quantity shares were partially buoyed by the Swiss National Bank's exchange rate peg through early 2015. Finally, a more multilateral reserve currency environment is becoming increasingly apparent, with currencies other than the dollar, euro, and yen gaining a toehold.

The big news in the COFER data released on September 30 was the partial addition of a representative sample of China's reserves to the reported total. The addition of these new data distorted the 2015 Q2 COFER release, contributing to raising reported reserves of participating countries (allocated reserves) by $604 billion and reserves of nonparticipating countries (unallocated reserves) down by $580 billion.

An earlier blog post provides estimates for the amount of China's participation.³ To gauge trends in global reserves in the second quarter, it is useful to walk through the methodology, which will help tease out the value and quantity share stories for the latest quarter.

The reported change is the difference between 2015 Q2 and 2015 Q1 allocated and unallocated reserves for all countries with the sign reversed for the unallocated reserves that declined. The dollar deprecated on average in the second quarter, boosting the value of nondollar holdings. The Q1 data is adjusted for the extent of that depreciation, assuming that the currency composition of the unallocated reserves was the same as that of the allocated reserves. This adjustment reduced the Q1-Q2 change for the allocated reserves and increased the change for the unallocated. There was also some net intervention in Q2. It is assumed there was the same amount of intervention as in Q1, which is estimated as the difference between the valuation-adjusted (the dollar appreciated) levels of reserves in Q4 and the level of reserves in Q1. (Without the intervention, the Q2-Q1 change would have been higher in the allocated reserves and lower in the unallocated reserves.) The estimated total intervention of $115.9 billion is very close to the combined total change in reserves from Q2 to Q1 with the valuation adjustments applied to the level of allocated and unallocated reserves in Q1, which was $109.2 billion.

What are the corresponding trends through the second quarter? Broadly speaking, valuation (exchange rate) effects from an appreciating dollar (temporarily interrupted by a small depreciation during Q2) have pushed up the value share for the dollar, while drawing down the value share of the euro and yen. The broad intervention (selling of reserves) story has meant that, adjusted for valuation effects, reported reserves have continued to decline.

Table 2 depicts value shares in reserves for the dollar, euro, and yen, and all other currencies for all reporting economies. For the dollar, there are two key factors to consider when reconciling its declining quantity share with its rising value share (figure 1).⁴ First, the dollar has appreciated against major currencies (those included in COFER) since mid-2014, even though the dollar depreciated in the second quarter. This brief depreciation (2.06 percent) was nearly erased with third quarter appreciation (1.91 percent), according to the Federal Reserve's Nominal Major Currency Dollar Index. In nominal terms, the dollar has appreciated 20 percent against major currencies since June 2014 through the end of the third quarter.

The second factor has been a shedding of reserves (dollars primarily, after adjusting for exchange rates) by emerging-market and developing countries (EMDC) after years of steady accumulation (figure 2). From the second quarter of 2014, total reserves have declined by over a half trillion dollars, and EMDC reserves declined by just over $750 billion, in unadjusted terms. EMDC reserves have the potential to continue to decline amid impending US monetary tightening, declining commodity prices, and a persistent slowdown in growth.

The euro's value share has continued to decline (figure 3) since the second quarter of 2014, with depreciation vis-à-vis the dollar and the European Central Bank's commencement of quantitative easing playing strong roles. Though not a current event, the Swiss National Bank's exchange rate peg to the euro, beginning in August 2011 and formally ending on January 15, 2015, likely helped boost the euro's value and quantity share through large scale purchases of euro-denominated assets.

In sum, reserve selling (intervention) by emerging-market and developing economies helps to paint the wider story of the dollar's slipping quantity share among international reserves. Similarly, its stronger value share is largely a result of dollar appreciation and the depreciation of other currencies except the Swiss franc in 2015. The euro's declining value share is similarly a story of exchange rate movements, though the Swiss National Bank's peg from past quarters likely supported its value and quantity share until earlier this year. Finally, the global economy will continue on a trend towards a more multilateral reserve currency environment. As seen in table 2, currencies other than the dollar, euro, and yen have maintained and expanded their value shares, and now represent approximately 12 percent among all reporters. Additionally, the recent ascension of the renminbi to the SDR basket and the associated opening of the renminbi market to foreign official holdings may accelerate this process towards diversification.

Notes

1. Value share changes are the change in the US dollar value of each currency at the end of one quarter minus the dollar value of the currency at the end of the previous quarter. Value shares are the shares of each currency valued in US dollars divided by the total of all currencies in US dollars. For a more technical explanation of value and quantity changes, see Truman and Wong (2006) and Wong (2007).

2. Quantity share changes for each currency are derived by multiplying the changes in official holdings of each nondollar currency from the end of one quarter to the next by the average of the two US dollar prices of that currency prevailing at the corresponding dates, and adding that change onto the quantity at the end of the previous quarter to construct the quantity series with a starting date of 1999 Q1. These values are added up along with the amount of US dollars to obtain a total, and shares of the total are calculated to obtain quantity shares; see Truman and Wong (2006) and Wong (2007).

3. Beginning in the second quarter of 2015, the IMF will no longer release the COFER breakdowns for advanced or developing countries, and only the world breakdown will be available.

4. Approximately half (42 percent) of total reserves are not captured in the COFER survey; they are "unallocated reserves" with no currency breakdown. Those data are not used in computing value and quantity shares in this analysis.