Updated: Feb 27
Sanctions following the Russia-Ukraine conflict have triggered much discussion on the impact of how other countries would manage their foreign currency reserves going forward.
After sanctions on Russia, a new debate has grown, what if in the future other countries like India, Pakistan, etc get sanctioned? What will be the benefit of those foreign reserves then? Foreign reserves are basically insurance, which will help the nation whenever there is an economic crisis.
During World War, Italy was sanctioned by the USA without even determining whether they have enough foreign reserves for running their nation smoothly. Countries generally use US dollars as foreign reserves as these are the most stable ones.
Let me clarify you with an example, suppose Ram purchased a house worth 20 crores but within a few weeks the value of that house came down to 5 crores. Here you can see no stability in the amount.
So, in foreign reserves, we generally use those things which are more stable and would be available in the 'liquid' form. So, whenever there is a condition of crisis in the nation, we can use foreign reserves.
'Sanctions' seem to be the most promising tool over here behind the cutting down of US Dollars Reserves.
What made global FX reserves rise from USD 2 trillion to USD 12 trillion by 2014?
During the Asian Financial Crisis, they got to know the importance of those FX reserves. Continued to figure out, what amount will be good for their country in the FX reserves. Some said the amount should be enough to pay the mid-term debt of the nations.
But this didn't happen. The absolute quantum of global reserves is continuously falling for the last eight years.
In 2000 Reserves as a share of global GDP rose from 5.5% to 15.4% in 2014 but now it is below 14%.
In fact, India and Switzerland are those countries that bought dollar assets to prevent their respective currencies from volatility.
So, the primary reason over here is a sharp decline in FX reserves in China and Saudi Arabia.
What is the reason behind the fall of foreign reserves in China and Saudi Arabia?
Whenever a country is running in a current account surplus it will accumulate more foreign assets over time. The foreign asset holdings of China and Saudi Arabia have grown steadily. It resulted in them stopping the sequestering of most of their foreign reserves.
This means, having liquid foreign assets held by a state actor to use in a period of economic crisis. So, the share of reserves in total foreign assets has fallen from 27% to 20% over the past decade.
Rise of other Currency Reserves
The share of the USD in global FX reserves has indeed fallen from 71% in 1999 to 59% in 2021, with nearly half of the decline occurred in 2014.
This has shifted to the euro, the yen, the British pound, and the Chinese yuan.