Column: Russia central bank freeze may hasten 'peak' world FX reserves

Illustration shows Russian Rouble and U.S. Dollar banknotes
Russian Rouble and U.S. Dollar banknotes are seen in this illustration taken, February 24, 2022. REUTERS/Dado Ruvic/Illustration/File Photo

March 2 - An end to the era of foreign currency stockpiling may be nigh.

This week's dramatic freeze of the Russian central bank overseas assets in response to Moscow's invasion of Ukraine may now question just why countries build foreign currency reserves at all.

G7 and European Union governments on Saturday moved to block certain Russian banks' access to the SWIFT international payment system - but went one step further than many expected by paralyzing about half the Russian central bank's $630 billion worth of foreign currency and gold reserves. read more

In what one Washington lawyer described as the "biggest hammer in the toolshed", the move undermines Moscow's ability to defend the rouble - which has lost up to a quarter of its value since Friday alone - or recapitalise its sanctioned banks as they face nascent bank runs. read more

The United States, at least, also sanctioned the Russia sovereign wealth fund, the Russian Development Investment Fund.

While a huge blow for Russia's economy, the move quickly prompted questions about whether targeting reserve holdings as an act of 'economic warfare' may prompt a rethink by reserve managers across the globe - not least in countries that may be at loggerheads or face a potential conflict with U.S. or EU governments - over where to bank their national stash.

It's a potentially huge issue for world markets given that central bank foreign currency reserves totalled a record $12.83 trillion late last year - a rise of $11 trillion over the past 20 years. This money is held mostly in U.S. and European government bills and bonds - with the U.S. dollar still accounting for almost 60% of that and the euro about 20%.

Since the annexation of Crimea in 2014, Russia's central bank had steadily divested its reserves of most U.S. dollar assets. But the dollar, euro and sterling still account for more than 50% of its holdings, located in France, Germany, Japan, Britain, the United States, Canada and Australia.

With Moscow and Beijing increasingly allied on the geopolitical stage and China refusing to either condemn the Ukraine invasion or join Western sanctions, China's yuan - currently accounting for just 2.7% of world reserves - may be one clear option for anxious reserve managers in Moscow or elsewhere.

But of course China itself - for all its fraught relationship with the West - has been the biggest reserve stockpiler since it joined the global trading system 20 years ago amid tight control of its exchange rate. More than $3 trillion of its $3.22 trillion hoard was amassed since 2000 - precisely to offset foreign inflows to keep a lid on the yuan.

World FX Reserve Stockpiles
Breakdown of reserves held by Russia's central bank


A big question for many economists is whether reserve managers seeking safe, liquid havens for hard cash built up through fixing or capping domestic currencies or via commodity windfalls may pre-emptively reshuffle holdings to avoid heightened sanctions risk - either in the current environment or for some undetermined future reason.

The quick answer from most experts is that there's simply no real alternative at the moment for most countries. And there was little adverse reaction in western bond markets this week to such talk - quite the opposite, if anything.

Even though Chinese government bonds have been a darling for many asset managers in recent years, there are few other destinations as large or as liquid - or as free from market or credit risk - than the U.S. Treasury or core EU sovereign debt markets.

China's yuan may seem obvious - but Beijing is deliberately slow to liberalize its financial markets. It retains the right to intervene frequently to support its own political priorities and has only taken about a quarter of the 10% share of world reserves ceded by the U.S. dollar since 2000.

But that's not to say there will be no impact.

Berkeley professor and long-standing expert on world reserve management Barry Eichengreen reckons that of the two imperatives behind reserve stockpiling - to intervene or stabilize domestic markets or as a war chest against shocks, disasters or balance of payments crises - the latter may now be in question.

"The main effect may be declining demand for reserves," he said.

"If countries see reserves and foreign exchange management as less useful and available, then they will have to accept the inevitability of that their exchange rates are likely to move by more," Eichengreen added. "In which case they need harden their financial systems and economies against exchange rate related disruptions, for example by discouraging corporates from borrowing in foreign currency."

That in itself could have a profound impact on world markets and on the model for emerging markets and developing economies.

Former Goldman Sachs global economist Jim O'Neill said it could ultimately lead to major reform of the global system.

"Amongst the fallout some countries may see less need to accumulate FX reserves," he said, adding that could indeed seed "peak reserves" worldwide.

"It might (also) make some of the bigger emerging markets think more seriously about reform and opening up their domestic markets, liberalising and moving away from the U.S-centric system."

RUB worst performing FX this year
US Treasury table on holders of Treasuries

The author is editor-at-large for finance and markets at Reuters News. Any views expressed here are his own.

By Mike Dolan, Twitter: @reutersMikeD - additional charts by Andy Bruce and Marc Jones Editing by Tomasz Janowski

Our Standards: The Thomson Reuters Trust Principles.

Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.

Thomson Reuters

Mike Dolan is Reuters Editor-at-Large for Finance & Markets and has worked as an editor, correspondent and columnist at Reuters for the past 26 years - specializing in global economics, policymaking and financial markets across the G7 and emerging economies. Mike is currently based in London, but has also worked in Washington DC and Sarajevo and has covered news events from dozens of cities across the world. A graduate in economics and politics from Trinity College Dublin, Mike previously worked with Bloomberg and Euromoney and received Reuters awards for his work during the financial crisis in 2007/2008 and on frontier markets in 2010. He was a regular Reuters columnist in the International New York Times between 2010 and 2015 and currently writes twice weekly columns for Reuters on macro markets and investing.