According to the OECD, foreign exchange rate reserves are the stocks of foreign currency denominated assets plus gold, held by a central bank. More simply, they are the assets of the central bank held in currencies outside the home country currency.

Author: Tiziana Barghini

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A reserve currency, also called an anchor currency, is a currency that is held in significant quantities by numerous governments and central banks as part of their foreign exchange reserves. These currencies are used to transact global business, and are the pricing currency for global trade—particularly in commodities such as gold, and oil.

The primary reserve currency used worldwide is the US dollar, followed by the euro—the official currency of the eurozone -- the British pound, the Japanese yen, and the Swiss franc.

Foreign exchange reserves data is released quarterly by the IMF in its Currency Composition of Official Foreign Exchange Reserves (COFER) statistics. COFER consist of a monetary authority’s claims on non-resident liquidity in the form of: foreign bank notes, bank deposits, treasury bills, short- and long-term government securities, and other claims usable in the event of balance of payments needs.

The amount of foreign exchange reserves that a country can claim is used as an indicator of the ability to repay foreign debt, and is used in sovereign credit ratings. Reserves are also used for currency defense—to halt downward or upward pressure on a currency against a benchmark currency. Closely related to foreign reserves, and also affecting debt repayment capability and credit ratings, are holdings in sovereign wealth funds.

Rebuilding Reserves

Over the last decade, countries in the developing world have been growing their foreign exchange reserves at an impressive rate, expanding them several times over. If, in 2004, Advanced economies held less around 20% more reserves than Emerging and Developing economies (with US$2 trillion to US$1.67 trillion), by 2013 this relationship had more than flipped, with Emerging and Developing economies controlling more than double the reserves of Advanced economies (US$7.9 trillion to US$3.8 trillion).  

During the Great Recession of 2007-2009 global reserves dropped from a peak of almost $7.5 trillion in mid-2008 to just under $7 trillion by February 2009, primarily as countries tried to manage currency depreciation and used reserves to fund stimulus packages. By the end of the first quarter of 2009, foreign reserves had once again begun to rise—and that trend continued since.

According to the CIA’s World Factbook, the top ten foreign-exchange holding countries -- China, Japan, European Union, Saudi Arabia, Switzerland, Russia, Taiwan, Brazil, South Korea and Hong Kong – have over two-thirds of global reserves.

The amount of reserves that a country should hold is not set in stone, although one common benchmark is holding enough to cover external debt for one year.

Changing the Reserve Currency

The dominance of the US dollar has long been a source of contention between the world’s largest economic players, in part because it allows the issuing country—namely the United States—to purchase commodities at a small discount as they do not have to incur the exchange rate charges, although this charge becomes minimal for major currencies. In addition, the issuing country has an advantage in terms of cost of borrowing as it means the market for that currency is generally stronger than for other currencies.

Global economists and policymakers have long proposed that a currency other than the US dollar should be the main reserve currency for global business. Countries such as Russia and China, along with a number of central banks and economists have suggested the use of an independent currency to replace the dollar.

In March 2009, Zhou Xiaochuan, governor of the Central Bank of China, posted an open letter on the Central Bank’s website calling for a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”.

He advocated the use of a new currency based on the Special Drawing Rights of the IMF. Special Drawing Rights (SDRs) are international foreign exchange reserve assets, allocated by the IMF to nations, which represents a claim to foreign currencies.

Proponents of SDRs suggest tying them to a basket of currencies—including the US dollar, the euro, the yen and the pound--to create a new, independent currency. In late 2009 UNCTAD relea