Central Bank Foreign Exchange Reserve Accumulation Slows

Central Bank Foreign Exchange Reserve Accumulation Slows

February 2015
Jack Malvey, CFA   |   Chief Global Markets Strategist, BNY Mellon Investment Management
Kishlaya Pathak, CFA   |   Global Markets Strategist, BNY Mellon Investment Management
Scott Helfstein   |   Global Markets Strategist, BNY Mellon Investment Management
Bryan Besecker   |   Investment Analyst, BNY Mellon Investment Management
Lale Akoner   |   Investment Analyst, BNY Mellon Investment Management

  • After quadrupling since 2003, central bank foreign exchange reserve growth slowed to 1.9% in 2014

  • Sluggish global growth, U.S. dollar strength and falling oil prices all contributed to the slowdown

  • Weaker central bank demand for fixed income might lead to higher yields over time and lower risk tolerance for central banks

The tremendous accumulation of foreign exchange reserves by world central banks has been one of the great financial market narratives of the early 21st century. Between 2003 and 2007, foreign exchange reserves more than doubled from $2.8 trillion to $6.1 trillion. Another almost-doubling occurred between 2007 and 2014 ($11.8 trillion).

Indeed, this data somewhat understates the prodigious reserve acquisitions. Some of the reserves were peeled away from central banks and dispatched to often newlycreated sovereign wealth funds.

Like virtually all trends in financial markets, the pace of foreign exchange reserve buildups has shifted, meaningfully decelerating and even reversing for some institutions. As shown in Figure 1, world foreign exchange growth plummeted to 1.91% in 2014 from a 5-year velocity of 9.05% and a 10-year tide of 12.81%. Given the substantive appreciation in the U.S. dollar, sluggish global growth and particularly the fall in energy prices, this statistical observation should not entirely surprise. Over 2014, oil-producing nations experienced a 7.8% decline in their foreign exchange reserves. Concurrently, Asian export-dependent economies, often directly or indirectly pegged to the strengthening U.S. dollar, managed only a 0.76% augmentation of their foreign exchange reserves in 2014.

Figure 1 // Foreign Exchange Reserves1 (U.S. $trillion): World, Asia and Oil Producers: 2003 to 2014

1 Excludes gold; may not add to total due to rounding; Asia countries include China, Japan, India, Taiwan, South Korea, Singapore, Hong Kong, Malaysia, Thailand, Indonesia, Philippines, Laos, Cambodia, Pakistan; Oil Producing countries include Algeria, Angola, Ecuador, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, U.A.E., Venezuela, Russia, Norway; Nigeria data available until 2012.
Source: BNY Mellon using data from Bloomberg.

Figure 1 // Foreign Exchange Reserves (US $trillion): World, Asia and Oil Producers: 2003 to 2014

Figure 1A Table // Foreign Exchange Reserve Growth Rates (%, cagr)
  Prior 11-yrs Prior 10-yrs Prior 5-yrs Prior 1-yr
World 13.76 12.81 9.05 1.91
Asia 12.96 11.51 7.21 .76
Oil Producing 19.09 17.14 4.96 -7.80
Other 13.61 14.35 17.88 11.08


Figure 1B Table // Projected Foreign Exchange Reserves (U.S. $trillion) to 2025 under Various Growth Rates (cagr, %)
  -2% 2% 5% 7%
World 9.42 14.62 20.11 24.75
Asia 5.75 8.92 12.27 15.10
Oil Producing 1.26 1.96 2.70 3.32
Other 2.41 3.74 5.14 6.33

As with every financial market parameter, numerous assumptions govern long-term predictions of foreign exchange reserve growth. For example, oil might regain its lofty $100+ per barrel valuation. World output expansion may eventually advance at a quicker clip, led by the U.S., and by definition in this largely floating-exchange rate era, future perturbations in exchange rates could well favor export-reliant nations.

Given this forecasting challenge, a multi-scenario table provides better guidance than a singular point forecast. Accordingly, Figure 1 includes a table of projected foreign exchange reserves to 2025 under four growth scenarios ranging from -2% to 7%. In our view, the most reasonable assumptions point to a growth rate of between 2% and 5%. The extraordinarily low yields available in the world bond market also influence our opinion. On February 5, 2015, the average yield on the Barclays Global Aggregate Index was only 1.45%. Given that many central banks invest mainly at the short and intermediate part of yield curves, as well as the negative yields out to intermediates in many parts of the European debt theater, the coupon flow from existing bond holdings will not provide much reserve growth lift.

Altogether, this analysis implies an appreciation in foreign exchange reserves from $11.8 trillion at the end of 2014 to between $14.62 trillion (2% growth) and $20.11 trillion (5% growth) by the end of 2025.

Next, we calculated the proportion of central bank foreign exchange reserves to the global financial asset choice set under various scenarios in 2025 as specified in Figure 3. This calculation hinged on first deriving the size of the global financial asset choice set as shown in Figure 2.

Figure 2 // Global Financial Asset Choice Set: December 31, 2014

1 Barclays indices data as of December 31, 2014 except U.S. commercial and industrial loans, non-agency U.S. MBS (September 30, 2014), and cash and cash-like6 (see below);
2 Global equity market capitalization per Bloomberg;
3 2012 private equity global AUM x 2003 to 2012 CAGR;
4 U.S. data as of September 30, 2014; non-U.S. real estate estimated from 2014 U.S. share of global GDP;
5 BIS data as of June 30, 2014, and may not add up exactly to total due to rounding;
6 Cash and Cash-Like: M2 money supply except for India which excludes other deposits with Reserve Bank of India (RBI) as defined by RBI; converted to U.S.$ using most recent data and exchange rates as of December 31, 2014 for Brazil, Canada, China, Eurozone, Hong Kong, India, Japan, Russia, Singapore, U.K., and U.S.; dates of most recently published data do not exactly match.
Global Financial Asset Choice Set intended to be a representation of various market values as defined by the footnotes above and should not be construed as a complete representation of all assets or markets. Sum of asset class components and all asset classes may not add up exactly to total due to rounding.
Source: BNY Mellon using data from FactSet, Bloomberg, Barclays Live, IMF, BIS, Preqin, and Reserve Bank of India.

Figure 2 // Global Financial Asset Choice Set: December 31, 2014

Figure 2A Table // Projected Global Financial Asset Choice Set (U.S. $ trillion) to December 31, 2025, under Various Growth Rates (cagr, %)
Source: BNY Mellon using data from FactSet, Bloomberg, Barclays Live, IMF, BIS, Preqin, and Reserve Bank of India.
  3% 5% 7% 10%
Total 559.8 691.7 851.2 1,153.8

As depicted in Figure 3, central-bank reserves would constitute only 0.82% of the world financial system if the overall market grows by 10% per annum on average while foreign exchange reserves contract at a 2% rate. At the other end of the spectrum, foreign exchange reserves could represent about 4.42% of financial system assets should reserves advance by 7% per annum accompanied by 3% growth of the total financial asset choice set.

The conclusions from this analysis:

  • The growth rate of foreign exchange reserves has peaked and likely will not revert to its breathtaking velocity of 2003-2013 during 2015-2025.
  • Nonetheless, foreign exchange reserves will continue to represent a mighty pool of capital, tasked with the unique purpose of stabilizing local and global financial markets.
  • The corollary to the abatement of incremental demand for fixed income securities from central banks may ultimately contribute to strategic headwinds for the maintenance of hyper-low yields across the world bond market.
  • Such capital market conditions will likely reinforce central banks’ preference for conservative investment courses. Reduced capital inflows, in some cases, may also curb portfolio risk tolerance by central banks
Figure 3 // Size of Global Foreign Exchange Reserves as a Percentage of Global Financial Asset Choice Set at the end of 2025 under Several Growth Scenarios
See footnote for Figure 1 and 2 for definitions.
Source: BNY Mellon using data from FactSet, Bloomberg, Barclays Live, IMF, BIS, Preqin, and Reserve Bank of India.
    Global Financial Asset Choice Set Growth (cagr, %) to 2025
Global Foreign Exchange Reserves Growth (cagr, %) to 2025   3% 5% 7% 10%
-2% 1.68 1.36 1.11 0.82
2% 2.61 2.11 1.72 1.27
5% 3.59 2.91 2.36 1.74
7% 4.42 3.58 2.91 2.15

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