On the composition of Asian central bank reserves: Will the euro replace the dollar?

Abstract

Recent discussion in the financial markets has considered the possibility that Asian central banks might be shifting some of their international reserve holdings out of the dollar and into the euro. Prompted by this recent interest, we empirically examine the composition of central bank reserves in Japan, China, and Korea. The currency composition of reserves is a well-guarded secret for these central banks, so we offer statistical estimates of the quantity of euro reserves held based on the time series properties of total reserves and the value of the euro. We find that, over the period 1999–2004, euro reserves may average 1/3 of the total reserves of these countries. In contrast, in the pre-euro period 1993–1998, reserves in currencies that were replaced by the euro were generally insignificant. Because there has been a large build-up of foreign currency reserves in Asian central banks, the rise in the holdings of euros was likely accomplished without selling dollars and buying euros. However, euro acquisition must have amounted to nearly half of the large build-up in reserves. The main conclusion is that the euro is likely to be increasingly important in Asian central bank reserve portfolios, and may surpass dollar holdings if Asian central banks see the benefits of currency diversification or if Asian currencies reduce their traditional stability vis-à-vis the dollar in favor of a link to a currency basket.