The unprecedented printing of notes by global central banks has resulted in expansion of foreign exchange reserves of most countries since last April.

Total foreign exchange reserves increased 7 per cent from $11.7 trillion towards the end of March 2020 to $12.6 trillion by March 2021. Even though more than half of official allocated reserves are held in the form of US dollar-denominated assets, many countries seem to have preferred to buy assets denominated in other currencies in 2020-21.

According to IMF’s COFER statistics, claims in US dollar held as part of official reserves of countries increased just 3 per cent last fiscal year. Increase in assets denominated in other currencies — such as the Chinese Renminbi (30 per cent), Australian dollars (26 per cent), Swiss Francs (25 per cent) — were far higher. This indicates that countries have been allocating incremental increase in their forex reserves to home currencies or other reserve currencies.


Why the shift

The reason behind this trend is not hard to find. The Federal Reserve’s strategy to do ‘whatever it takes’ to save the economy has resulted in increasing its balance sheet by over $4 trillion since last March. This splurge has resulted in debasing the dollar value significantly. Also, the Fed fund rate moving close to zero has resulted in very low returns on US treasury instruments. Other central banks may have wanted to move some part of their reserves to assets in better yielding currencies.

Countries such as China, which want to improve the acceptance of their home currency seem to have made it a point to stock their home currencies in the reserves.

This shift is also apparent in the falling share of US dollar denominated assets in total allocated official reserves. Dollar has traditionally been the preferred currency for official reserves due to its wider acceptance in international trade and other financial transactions.

Around 62 per cent of allocated reserves were held in the form of dollar assets until the end of March 2020. This share has declined to 59.54 per cent by the end of this March. Euro, followed by the Chinese Renminbi have seen the largest increase in their share of reserves in the last fiscal year.

India bucks the trend

India too seems to have been aware of the pitfalls in increasing its dollar holdings. While India’s holding of US treasury securities increased steadily from $182.7 billion in June 2020 to $220.2 billion by October 2020, there was a gradual decline in holding thereafter to $200 billion by March 2021. But from April, the RBI is once again increasing its dollar holding with dollar security holding amounting to $220 billion by June 2021.

The decline in yields on US treasury securities along with the prospect of monetary tightening by the Fed could be some of the reasons behind this change. Lack of alternative avenues to deploy India’s reserve holding is another reason.