Box 1
The Russian invasion of Ukraine and international currencies

Prepared by Maurizio Michael Habib and Arnaud Mehl

The Russian invasion of Ukraine and financial sanctions imposed on Russia, such as the decisions to freeze about half of its official foreign reserves and to ban selected Russian banks from SWIFT,^[4] have fuelled speculation about the implications of these developments for the prospective roles of the US dollar and the euro globally.

It has been argued that the recent sanctions might provide a fillip to countries seeking to bypass the US dollar and the euro in the international monetary and financial system.^[5] Russia had already cut its US dollar exposures significantly after the seizure of Crimea and the introduction of international sanctions in 2014. Russia had diversified its official foreign reserve holdings of USD 630 billion away from the US dollar, had attempted to shift the currency denomination of its international payments and reduced domestic dollarisation. By mid-2021, gold exceeded the US dollar in Russia’s official foreign reserves – equating to 22% compared with 16% for the US dollar. The share of the renminbi, at 13%, was close to that of the US dollar, while euro-denominated assets accounted for the largest share (32%). Virtually all of Russia’s official holdings of US Treasuries have been liquidated.^[6]

Following the latest sanctions, Russia and other countries may, it is alleged, diversify their portfolios further away from the US dollar and other traditional reserve currencies into other assets, such as the renminbi, gold and crypto-assets. They may try to find alternatives to SWIFT for international payments, such as China’s Cross-Border Interbank Payments System, which would bolster the renminbi’s global role. International payment systems could become more segmented. Russia has demanded that importers of Russian gas should no longer pay in dollars or euro, but in roubles. The Russian invasion of Ukraine is therefore seen as accelerating the “stealth erosion” of the US dollar’s role as a global reserve currency. Since the turn of the millennium, the share of the US dollar in global foreign exchange reserves has declined by more than 10 percentage points, mainly to the benefit other non-traditional reserve currencies, including the Chinese renminbi (see Chart A).^[7]

However, the implications of these developments on the global appeal of the major international currencies remain unclear.

First, the direction of causality between reserve management decisions and other international currency uses matters. Recent research has pointed to the fact that the role of a currency in global trade and finance determines its importance in global foreign exchange reserves.^[8] There are strong complementarities between the various functions of international currencies, but causality flows primarily in one direction. Therefore, unless more significant changes to international payments or debt issuance patterns occur, shifts in the currency composition of global reserve portfolios might not necessarily herald broader changes in other dimensions of international currency use.^[9]

Second, although the share of the US dollar as a global reserve currency has declined, in other dimensions of international currency use, it has remained stable, such as in global foreign exchange turnover and for the invoicing of global trade, or it has increased significantly, such as in international bond issuance.

Third, alternatives to major international currencies often lack the depth, liquidity or other economic and financial attributes required to appeal to global investors. At more than USD 23 trillion, the US Treasury market remains deeper and more liquid than markets in any other safe assets, including the euro government debt market, which is still fragmented among different issuers.^[10] China’s government debt market in renminbi, at more than USD 7 trillion, might offer an alternative to US Treasuries in the medium term. The share of the renminbi in global official foreign exchange reserves has more than doubled since 2016 to almost 3% in 2021. However, despite recent measures to lift restrictions, access to renminbi-denominated bonds and bank deposits for foreign official investors is not fully liberalised. The rebalancing of global official foreign exchange reserves away from the US dollar in the past two decades has mostly benefited currencies more easily traded than the renminbi (see Chart A).^[11] Foreign official investors hold between one-fifth and one-third of the stock of general government debt issued by the United States, the euro area or the United Kingdom, but less than 5% of the stock issued by China (see Chart B). About a quarter of the USD 12 trillion in global official foreign exchange reserves are held by China and cannot be diversified into renminbi. Gold may not be a more attractive alternative for official reserve managers seeking to diversify away from the US dollar or the euro, being neither remunerated nor usable for international payments; it is also subject to physical storage costs. Rebalancing portfolio holdings into crypto-assets is challenging, too. Some of the crypto-assets, such as bitcoin, are supplied in fixed quantities, have highly volatile prices and behave similarly to risky speculative assets. This makes them unappealing to official reserve managers. Stablecoins might be more attractive in the future. However, at least so far, they may lack guarantees in terms of redeemability – if issuers are able to lock tokens in the wallets of holders – and the required scale, with a market capitalisation of just USD 185 billion in 2021 – only 1% of global foreign exchange reserve holdings. Most stablecoins are pegged to the US dollar, which suggests that complementarities between the various uses of international currencies benefit the incumbent unit – the US dollar.^[12] In addition, financial supervisors are increasingly scrutinising market transactions to identify those that might be conducted with a view to evading financial sanctions, and encourage crypto exchanges to remain mindful of reputational risk.

Chart A

The decline of the role of the US dollar in global foreign exchange reserves

Change in the share of selected currencies in global official holdings of foreign exchange reserves since 1999

(percentage points, at constant Q4 2021 exchange rates)

Finally, the Russian invasion of Ukraine might serve as a reminder of the relevance of sound institutions, macroeconomic fundamentals, including price stability over the medium term, and geopolitical considerations as determinants of international currency status. Research suggests that, since the early nineteenth century, the leading international currency or currencies have been those of countries where the rule of law is respected, which emphasise checks and balances, build durable international alliances, and where creditors are well represented.^[13] Moreover, research also stresses that the choice of international reserve currencies depends on broad strategic and geopolitical considerations. In particular, one study found that military alliances boost the share of a currency in the partner’s foreign reserve holdings by about 30 percentage points.^[14]

Overall, time will tell whether more significant changes in the international role of currencies will unfold. What is possible, however, is that the Russian invasion of Ukraine might have acted as a catalyst in related domains. For instance, some countries have accelerated plans to explore central bank digital currencies (CBDC) in the wake of the invasion, which may have implications for the global appeal of major currencies.^[15]

Chart B

Share of foreign official investors in government debt: high for the US dollar and the euro, low for the Chinese renminbi

Share of foreign official holdings of outstanding general government debt

(percentages)

Box 2
The internationalisation of the renminbi: regaining strength?

Prepared by Pablo Anaya Longaric and Paola Di Casola

Notwithstanding earlier predictions that the renminbi would dethrone the US dollar as the leading international currency, the global role of the renminbi remains more limited than the shares of China in global trade and output.^[18] In 2021 China accounted for 19% of global output, whereas the share of the renminbi in various measures of international use was much lower (see Chart A).

Several recent developments, however, might herald signs of a potential turnaround in the international role of the renminbi. First, China has made rapid progress in the development of a digital yuan which, if allowed to be used across borders, could support the international role of the renminbi. In January 2022 China launched a large retail central bank digital currency pilot project to enable domestic residents and foreign visitors to the Winter Olympics in February 2022 to use the digital yuan, with some restrictions. Take-up by foreigners during the Winter Olympics was limited. However, the digital yuan may still be used at some point in the future to settle a share of Chinese imports and exports, for example in the context of the Belt and Road Initiative, thereby supporting the global status of the Chinese renminbi.^[19]

Another relevant development pointing to an increase in the international appeal of the renminbi was the inclusion of Chinese bonds in major global bond benchmarks.^[20] In line with evidence for other emerging markets in the past, this development led to an increase in foreign ownership of Chinese domestic government bonds, especially among US and euro area private sector investors.^[21] For example, fixed-income funds domiciled in and operating outside the United States increased their exposures to assets denominated in renminbi from close to zero in 2017 to over 5% of total assets in 2021.^[22] A further factor that may potentially support the international role of the renminbi is the resilience of the net capital flows to China – especially inflows – which remained positive in the past years. In particular, net bond inflows amounted to USD 147 billion in 2020 and USD 53 billion in 2021, despite the COVID-19 pandemic.

Finally, according to some observers, the recent Russian invasion of Ukraine and the financial sanctions imposed on Russia could accelerate a rebalancing of global reserve portfolios and payments away from the US dollar and the euro towards the renminbi (see Box 1 in this report).

Based on the evidence to date, the share of the renminbi as a reserve currency has increased in the recent years, but remains modest compared with other major currencies, at around 2.8% of global official foreign exchange reserves in 2021 (see Chart A(a)). Since 2020, the countries with the largest share of official foreign exchange reserves in renminbi have included Russia (17%) and Tanzania (16%).^[23] Use of the renminbi as an international financing currency remains limited; renminbi-denominated bonds account for less than 1% of the total issuance of international bonds. Use of the renminbi for international loans, i.e. by lenders resident outside China, is negligible (see Chart A(a)). However, cross-border lending by Chinese institutions has grown significantly. Based on available data up to 2017, China has become the world's largest official creditor, ahead of the World Bank and the IMF.^[24] In the period 2000-2017, the average share of the renminbi in China’s official lending was 11%. The renminbi share is usually higher in Asia and Africa (see Chart B) and when loans are provided on concessional terms, through a government agency, with a developmental or representational intent.^[25]

In terms of cross-border payments, SWIFT data point to a pickup in the share of the renminbi to above 2% in 2021 (see Chart A(a)). In December 2021 the renminbi exceeded the Japanese yen as a global payment currency by value, becoming the fourth most active unit, behind the US dollar, the euro and the pound sterling. Use of China’s cross-border interbank payment system (CIPS), which the People’s Bank of China launched in 2015, has increased steadily. Average daily transactions have surged from RMB 8 billion in value in 2015 to RMB 334 billion in 2021. The volume of transactions in CIPS remains roughly 1% of the volume of global payments handled by the SWIFT system, but it might rise further following the imposition of sanctions on Russia, such as the ban of some Russian banks from SWIFT. Use of the renminbi for invoicing imports and exports has also increased, although it remains at low levels (see Chart A(b)). Research suggests that renminbi invoicing has been supported by the establishment of currency swap lines by the People’s Bank of China and other central banks.^[26] Finally, more recently, following stable demand for yuan-denominated oil futures contracts, initially launched in 2018, China launched yuan-denominated energy options contracts open to foreigners.

Various factors might have hindered further progress in the international use of the renminbi. For instance, research suggests that geopolitical tensions, particularly China’s trade disputes with the United States, might have been one such factor.^[27] Incomplete openness of China’s capital and financial account (particularly for capital outflows), capital controls and the lack of full exchange rate flexibility are other factors believed to impair the internationalisation of the renminbi.^[28] The recent slight increase in the weighting of the renminbi as part of the revision of the Special Drawing Rights (SDRs) basket, which will come into effect in August 2022, may support the global profile of the renminbi.^[29] However, a clear-cut impact of the inclusion of the renminbi in the SDR basket in 2016 on the international role of the Chinese currency is not visible so far.

Chart A

Evidence of an increase in the global role of the renminbi from a low level

Chart B

China’s official lending in renminbi is more significant in some parts of Asia and Africa

Share of the renminbi in China’s official lending between 2000 and 2017

(percentages)

Box 3
New insights from sectoral developments in international loans

Prepared by Peter McQuade and Swapan-Kumar Pradhan (BIS)^[50]

This box provides insight into the international use of the euro as a financing currency across economic sectors and the related trends. It uses BIS international locational banking statistics (LBSs), which include information on international loans.^[51] The LBS statistics have been enhanced since the fourth quarter of 2013 to provide additional sectoral granularity and shed light on developments in financial linkages through internationally active banks. The box shows that euro-denominated international loans to non-bank financial institutions (NBFIs) have expanded in recent years and that the euro is an important financing currency in this segment of the international loan market.^[52]

Chart A(a) combines data on euro-denominated international loans with information on the euro legacy currencies. It shows the remarkable growth in amounts outstanding of euro-denominated loans in the past four decades. This expansion was largely driven by loans to banks until the mid-2000s. However, loans to banks declined substantially during the global financial crisis and the European sovereign debt crisis. By contrast, loans to non-banks have remained relatively resilient and continued to rise in recent years. These developments have led to a marked increase in the share of non-banks, which now account for about one-half of total euro-denominated international loans.^[53]

Chart A(b) shows the newly enhanced disaggregated data, which have been available since the fourth quarter of 2013. The data provide a breakdown of total euro-denominated international loans to non-banks into four sub-sectors, namely: NBFIs, corporates, government and households.^[54] Most of the recent rise in euro-denominated international loans is attributable to NBFIs. Data on breakdowns by counterparty and country (not shown in the chart) reveal that this is primarily due to loans to NBFIs located in the United States and the United Kingdom.

Chart A

Growth in euro-denominated international bank loans driven by loans to non-bank financial institutions

Chart B(a) shows a currency breakdown of total international loans across different non-bank sub-sectors. For loans denominated in euro, the share is highest for NBFIs, standing at around 33%, while the shares of loans to other sub-sectors are 12% for households, 15% for corporates and 23% for general government. By contrast, the US dollar’s importance is strongest for loans to corporates.

Chart B(b) shows the persistent growth in the total volume of international loans to NBFIs in all currencies (see the light-blue line), while the share of the euro has remained relatively stable (see the dark-blue area). The share of loans to NBFIs (in all currencies) in total loans to non-banks has increased from just over 43% in 2014 to almost 57% in 2021. The relatively rapid growth of loans to NBFIs may have therefore supported the international role of the euro through composition effects.

Chart B

The large share of the euro in loans to non-bank financial institutions has supported its role in international loan markets through composition effects

Overall, the importance of euro-denominated loans in total bank claims to NBFIs has implications for policy. From a global financial stability perspective, exposures of NBFIs located outside the euro area to euro-denominated-loans is a potential channel of spillovers from developments in euro area liquidity to global financial markets and vice versa. Moreover, given that NBFIs are expected to play an increasingly important role in the global financial system, further development of the NBFI sector may support the global appeal of the euro as a financing currency going forward.^[55]

Box 4
How important is invoicing currency choice for the impact of exchange rate fluctuations on trade?

Prepared by Martina Di Sano, Erik Frohm, Vanessa Gunnella

The magnitude and speed of the trade impact of exchange rate changes is of significant importance for economic activity and inflation. This is especially the case for open economies such as the euro area. Yet, structural characteristics, such as firms’ choices of invoicing currency for international trade and their participation in global value chains (GVCs), may influence the pass-through of exchange rate changes to trade prices and volumes.

The choice of invoicing currency for international trade has consequences for exchange rate elasticities. For countries or regions with widely used currencies, such as the euro area or the United States, trade adjustments to exchange rate changes manifest themselves mainly in export volumes but only to a small extent in import volumes. This is because, if prices are settled in an international currency, e.g. the euro, exchange rate variations would immediately translate into changes in export prices faced by customers in their own domestic currency, driving demand for euro area exported goods and services. Conversely, many euro area import prices are sticky in euro terms in the short run, i.e. they do not change with the exchange rate. Invoicing in euro thus lowers the pass-through of exchange rate fluctuations to import prices, limiting the implications of exchange rate fluctuations for euro area demand for imports.^{[56] [57]}

In this box, the dynamic reaction of trade prices and trade volumes to changes in the euro exchange rate is estimated on the basis of trade equations that consider structural factors, such as invoicing shares and GVC participation. In a sample of euro area bilateral trade with countries outside the euro area, panel local projections^[58] are used to examine the historical correlations between exchange rate changes and trade prices (in unit values) and trade volumes over a two-year horizon. The estimated equations take into account and investigate the role of the trading partners’ invoicing shares and GVC participation by means of interaction terms.^[59]

Higher trading partners’ euro invoicing shares are related to a stronger sensitivity of euro area export volumes and a lower sensitivity of trade prices to changes in the exchange rate. Chart A reports the estimated short-run (i.e. up to the first quarter, in Chart A(a)) and medium-run (i.e. up to two years, in Chart A(b)) elasticities of trade volumes and unit values, also accounting for the role of GVCs.^[60] While euro area import volumes do not seem to react to exchange rate movements regardless of the share of euro invoicing,^[61] export volumes rise more strongly following a euro depreciation when the share of exports denominated in euro is large with a partner country than they do when euro invoicing shares are low. As regards trade unit values, the higher the share of prices invoiced in euro, the less an exchange rate depreciation would affect prices, as shown in Chart A, where the unit values responses are nullified in the presence of high euro invoicing shares. These results are consistent with existing theoretical and empirical contributions.^[62]

Chart A

Trade elasticities vis-à-vis the exchange rate and invoicing currency

a) Effect of a 1 percentage point euro depreciation – short term

(percentage points)

b) Effect of a 1 percentage point euro depreciation – medium term

(percentage points)

In the event of strong exchange rate movements, invoicing thus plays a key role in terms of trade implications. Euro area export and import prices (and hence inflation) are partially shielded from large euro exchange rate movements when a sizeable share of trade flows is invoiced in euro. On the other hand, euro area export volumes respond more strongly, including in the short-to-medium term, when exports are invoiced in euro.

Box 5
Euro-based stablecoins

Prepared by Massimo Ferrari Minesso and Maurizio Michael Habib

Stablecoins are digital assets designed to minimise price volatility typically against a single fiat currency (or a basket of fiat currencies). There are different types of stablecoins – tokenised, collateralised, algorithmic – which use different mechanisms to ensure that stability against the target fiat currency is maintained.^[64] Price stability may vary significantly across different coins due to differences in the ways in which they are pegged, the type and volatility of reserve assets (if any) and their governance structure. Recent empirical evidence suggests that it is likely that stablecoins have acted primarily as a bridge between traditional fiat currencies and volatile digital assets and as collateral in crypto-asset derivative transactions.^[65]

From a financial stability perspective, due to full backing of their liabilities at par, stablecoins have been compared to money market funds or currency boards. However, stablecoins are particularly vulnerable to reserve outflows and therefore exposed to the risk of digital runs in the event that doubts about the backing of a coin issuance surface.^[66] Large-scale redemptions of stablecoin units, possibly triggered by confidence shocks, could lead to fire sales of reserve assets, creating disruptions in markets used to invest the reserves. Therefore, stablecoins should not be regarded as a new class of safe asset but rather as a less volatile but risky crypto-asset.^[67]

The vast majority of stablecoins are linked to the US dollar, which could support its international profile if private stablecoins were to gain broader acceptance.^[68] Stablecoins pegged to the euro have started to gain popularity, although the market remains in its infancy. Given the potential systemic importance of stablecoins should the market develop further in the future, this box aims to assess the role of the euro in this market and whether euro-denominated stablecoins follow trends specific to crypto-asset markets or those of traditional financial instruments.

The stablecoin market has boomed in the past two years. It was valued at about USD 160 billion in 2021. As shown by Chart A, the stablecoin ecosystem is strongly dominated by coins linked to the US dollar, which account for about 99% of total capitalisation. The two largest stablecoins, USD Tether and USD Coin, have a combined market capitalisation of about USD 120 billion. Euro-denominated stablecoins are the second largest market segment, but their value is very limited (about €500 million). Their share is very small, at about 0.2% of the total stablecoin market. The market for euro-denominated stablecoins is also dominated by two large coins, EUR Tether and Stasis euro, that together account for about half of the total.

Chart A

Stablecoin issuance has increased noticeably in the last two years

All major stablecoins trade at a small premium relative to parity on average (see Table A). This phenomenon might reflect the use of stablecoins as vehicles for crypto-asset trading or the existence of transaction frictions.^[69] Prices are also volatile and may fall below parity, although volatility is substantially lower than riskier crypto-assets, such as bitcoin.^[70] This is particularly the case for euro-based stablecoins that are traded on relatively small and shallow markets compared to US dollar-based coins.^[71]

Retail investors have significantly increased their exposures to crypto-assets since 2018. Recent analysis suggests that crypto and equity markets have become increasingly interconnected across economies and over time.^[72] The evidence can be re-examined by contrasting developments for Stasis euro (the most important euro-backed stablecoin, which has a history of over two years) and USD Tether (the largest stablecoin by market capitalisation) relative to a control group, which includes bitcoin and other financial variables. The analysis examines developments since 2020 – the period over which the stablecoin market has boomed – and consists in comparing returns in periods of global financial market stress, identified by large increases in the VIX index. The aim is to assess whether stablecoins are good hedges against global risk shocks.^[73]

Table A

Dollar and euro stablecoins

Characteristics of stablecoin premia since 2020

On average, USD Tether returns correlate positively – albeit to a moderate extent – with US dollar exchange rate returns, negatively with stock market returns, and they are uncorrelated with both bitcoin returns and the VIX index (see the blue bars in Chart B(a)). However, the correlation coefficients are not statistically significant. USD Tether returns do not therefore appear to be significantly associated with stock market nor with bitcoin price fluctuations. By contrast, returns for the euro-pegged stablecoin, Stasis euro, are positively and significantly correlated with stock market and bitcoin returns (see the dashed yellow bars in Chart B(a)). The value of Stasis euro, unlike that of USD Tether, declines when stock market volatility rises. This feature is also evident from the negative correlation between Stasis euro returns and the VIX index. Differences between US dollar and euro-linked stablecoin returns might reflect differences in relative liquidity and risk profiles. Euro-based coins are less liquid and tend to be sold similarly to other risky assets rather than behaving like a vehicle in digital transactions and trading.

A similar picture emerges from the analysis of high-risk episodes, defined as periods in which changes in the VIX index lie within the top 5th percentile of the distribution of weekly changes. In these episodes, stock market returns are negative (by around -1 to -1.5 percent), as are bitcoin returns (by around half a percent), as shown in Chart B(b). This suggests that investors sell risky assets and that bitcoin is considered to be a risky asset. Prices of stablecoins do not decline to a similar extent. However, returns on stablecoins become marginally negative when global financial market volatility rises, in particular those of Stasis euro, which depreciates by about 13 basis points, more than twice the average premium on this instrument. This suggests that investors sell stablecoins alongside other riskier asset classes, thereby raising potential financial stability concerns if larger shocks to global risk were to occur. This confirms the findings of recent studies on the stability of stablecoins.^[74]

Chart B

Stasis euro was not a good hedge against corrections in risky asset prices

Transaction volumes of stablecoins suggest that they are influenced by developments specific to crypto-assets. This is particularly the case for USD Tether, the largest stablecoin by market capitalisation. Chart C plots daily changes in traded volumes of stablecoins against those in bitcoin; it shows that purchases of USD Tether strongly co-move with bitcoin transactions (see Chart C(a)). For Stasis euro, the correlation is positive but less strong (see Chart C(b)). This suggests that euro-denominated stablecoins are used less frequently as vehicles for bitcoin purchases, perhaps because they are less liquid. Additional regression-based estimates show that financial market and crypto-assets returns explain a very low share of transactions in stablecoins. In contrast, transactions in stablecoins, particularly in US dollar stablecoins, are largely driven by transactions in crypto-assets. This suggests that stablecoins are not considered as a new financial asset class that investors would arbitrage against other asset classes, but as vehicles for transactions in more volatile crypto-assets.^[75] Potential risks triggered by more widespread stablecoin adoption could be managed through the existing Eurosystem’s oversight framework that covers stablecoin arrangements that qualify as payment systems, regardless of the technology used. Moreover, in Europe the issuance of stablecoins and provision of crypto-asset services will be regulated under the Markets in Crypto-Assets (MiCA) Regulation, which is currently at the negotiation stage between the European Parliament, Council and Commission. Any stablecoin transfer function that qualifies as a payment system would either need to comply with the ECB Regulation on oversight requirements for systemically important payment systems or be assessed against the Eurosystem’s oversight framework for retail payment schemes.^[76] These efforts would need to be complemented by stronger international cooperation on the regulation of crypto-assets.

Chart C

Transactions in stablecoins correlate with transactions in crypto-assets