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Central banks look to China’s renminbi to diversify foreign currency reserves

Central banks are looking to the renminbi to diversify their foreign currency holdings, a sign that geopolitical flare-ups could take away the dollar’s dominance.

According to an annual survey by UBS of 30 leading central banks, conducted between April and June 2022.

“We are seeing a gradual erosion of the dollar,” said Massimiliano Castelli, head of strategy for global sovereign markets at UBS. “The picture emerging is one of a multipolar currency system.”

The growing interest in the Chinese currency comes after Western powers froze about $300 billion in Russian foreign exchange reserves in response to the invasion of Moscow in early 2022, which turned Western powers against Russia and complicates relations with countries that do not participate in sanctions, including China. .

That accelerates a split between China and the US that had already begun during the Trump administration’s trade war. Four-fifths of central bankers surveyed said they believed moving towards a multipolar world — away from a US-centric system — would benefit the renminbi. Less than half said it would benefit the US dollar.

Concerns about high inflation in the US and the Federal Reserve’s efforts to combat it have also weighed on short-term dollar sentiment. Central banks typically hold dollars through US government debt, which has sold out sharply this year as the Fed tightened monetary policy.

Line chart of Share of allocated reserves (%) showing that the dollar's role in central bank reserves has declined

Reserve managers are looking to alternative assets such as equities, green debt and inflation-protected bonds amid concerns about US Treasury ownership, the study found. Nearly half of respondents said their portfolios are now more diversified compared to last year.

While the dollar remains by far the most important reserve currency in the world, its lead has declined in recent years. According to IMF data, it represented just under 60 percent of allocated reserves at the end of the first quarter of 2022, compared to 65 percent in the same period in 2016. However, the Chinese renminbi still accounts for a small chunk, less than 3 percent.

The majority of central bank reserve managers have added to their dollar holdings so far this year. Of the executives surveyed, 62 percent added to their dollar reserves in the past year, while 54 percent added to their renminbi holdings.

“Eventually we will see central banks and reserve managers thinking about what else they can have in their ammunition toolkit to combat volatility and macroeconomic events,” Castelli said.

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