International reserve assets diversification using the euro as one of the "poles" in the polycentric model of the global monetary and financial system

Ozarnov Ruslan ORCID: 0000-0003-4414-3452 PhD in Economics Associate Professor, Department of World Economy and World Finance, Financial University under the Government of the Russian Federation 125993, Russia, Moscow, Leningradsky Prospekt, 49/2 ozarnovr@gmail.com Other publications by this author

introduction

In modern geopolitical conditions, the development of proposals for the diversification of international reserve assets using the single euro currency as one of the "poles" of the polycentric model of the world monetary and financial system seems to be an urgent area of scientific and practical research. Diversification of international reserve assets is an important part of financial and economic policy, it allows reducing both the risks associated with reserves and managing volatility, including volatility in the financial market and foreign exchange, as a financial sector, since information about the composition of international reserves has an impact on economic agents operating in the financial market. In particular, they can consider data on international reserve assets as a fundamental source of information about the demand for a particular asset in a currency, which, in turn, can have both short-term and long-term effects.

RESEARCH METHODS

As research methods, the author applied general scientific methods of cognition, such as analysis, synthesis, comparison, graphical interpretation and analysis of statistical information and time series. The author used statistical data from various organizations, including the International Monetary Fund, the World Bank, the Bank of Russia and the Bank for International Settlements. In addition, the study is based on the study of foreign and Russian sources.

the main part

When studying the diversification of the structure of international reserves, a number of authors identify the following approaches. If the state is interested in achieving short-term goals related to trade cooperation and financial policy, then the main part of the reserve assets will be the currency of transactions and interventions in order to reduce transaction costs. If the goals of the state are related to the fulfillment of its debt obligations in the medium term, then the currency structure of reserve assets will be diversified depending on the currency structure of debt obligations. If the medium-term or long-term goals of the state are related to investment activities, then the currency structure of reserve assets will be formed taking into account factors such as risk and profitability. ^[1]

There are active, passive and stabilization diversification of international reserve assets. Passive diversification is associated with differences in interest rates, returns on assets denominated in different currencies and fluctuations in exchange rates. Another option is active diversification occurs when the state does not make purchases of foreign currency on the market for a certain period, but in response to the depreciation of one currency, sells assets in this currency and increases reserves in other currencies, which in turn further increases the depreciation of the currency. Stabilization diversification of international reserves takes place when countries believe that the depreciation of a reserve currency or asset is a temporary phenomenon, then they reduce the share of other reserve assets by selling them in order to increase the share, purchasing a depreciating reserve asset, which in turn will contribute to the support of a depreciating reserve asset.^[2]

An important task of managing international reserves is to protect the country's foreign exchange reserves from depreciation, and in this regard, there is a need for both their diversification and investment in low-risk assets. In addition, it is necessary to remember about the liquidity of reserve assets, which is provided either by investing in international freely convertible currencies and instruments, or by using short-term instruments. ^[3]

Experts in the field of diversification of international reserves note that the euro is an alternative asset suitable for the diversification of reserves, however, a change in the balance of reserves towards alternative assets and a move away from the dollar will have immediate consequences for both the US economy and the global economy as a whole. ^[4] It is worth noting that the designers of the single European currency saw it as a mechanism to counter the financial and economic expansion of the United States in the context of globalization, but the euro did not create proper competition for the American dollar. Figure 1 shows the exchange rate of the US dollar (USD) to the euro (EUR) from January 2012 to April 2023.

The euro can be considered as an international reserve asset and one of the "poles" of the polycentric model of the world monetary and financial system since the euro area:

? has an annual GDP commensurate with the US GDP (in 2022, the GDP of the euro area is about 17 trillion US dollars, and the US GDP is about 23 trillion US dollars) ^[5];

? has a significant domestic market;

? has a fairly integrated financial market;

? the economy of the euro area has the potential for development.

Figure 1 – The exchange rate of the US dollar (USD) to the euro (EUR) from January 2012 to July 2023.

Source: compiled by the author according to Statista ^[6]

Note that the exchange rate is influenced by various factors, both economic and non-economic. At the same time, the global use of the euro is provided by different economic agents and various institutions. The shares of currencies in the over-the-counter average daily turnover in 2004-2022 are shown in Figure 4. In general, it can be argued that the euro has achieved significant development as an international reserve currency since its inception, as experience shows, exchange rate stability and a developed economy can contribute to the internationalization of the currency, but the European Central Bank (hereinafter referred to as the ECB) must constantly monitor changes in exchange rates, their deviation from long–term equilibrium in order to develop and the adoption of appropriate monetary policy measures, since changes in exchange rates can have a negative impact on both the economic indicators of the euro area and on confidence in the ECB and thus on the role of the euro as an international reserve asset.

In addition to certain currencies, international reserves usually also include assets such as accounts in the SDR, a reserve position in the International Monetary Fund (hereinafter – the IMF), as well as monetary gold. Figure 2 shows the structure of Russia's international reserve assets for the period 2021-2023. In general, it can be argued that the structure of reserves is fairly stable, which corresponds to international experience: monetary policy authorities are cautious in managing and diversifying reserve assets, including foreign exchange reserves.

Figure 2 – International reserves, billion US dollars

Source: compiled by the author according to the Central Bank of Russia ^[7]

As of September 8, 2023, the volume of Russia's international reserve assets is 576.6 billion US dollars.^[8]

The inclusion of the US dollar in reserve assets is associated with the economic, financial and political policies implemented by the United States. ^[9] In the 1970s, immediately after the change of the Bretton Woods monetary system based on the US dollar, it accounted for a significant part of the countries' international reserve assets. In the 1980s and early 1990s, the share of the US dollar declined, but demand for it increased after the early 1990s and tended to increase until the financial crisis in Mexico and Asia, due to the rapid growth of the share of the US dollar in the reserves of developed countries from 52 to 65 percent, while while the quantitative share of the dollar in the reserves of developing countries fluctuated between 67 and 70 percent. ^[10] The end of the 1970s and the beginning of the 1980s were marked by both a tendency to weaken the dollar and the emergence of the European Monetary System. At the same time, it is worth noting that the change in the use of the US dollar as a reserve asset is associated with both passive and active diversification. In addition, as reserve assets denominated in US dollars increase and external liabilities also denominated in dollars increase, holders of international reserve assets will observe the so-called "concentration risk". ^[11]

In modern conditions, the role of the US dollar as a reserve asset is declining, countries are forced to look for an alternative to the US dollar. Globalization and the dominance of the US dollar, which have been observed over the past 76 years, may be weakened due to the sanctions applied by the US to other countries, in particular to Russia (see Figure 3).

Figure 3 – The most sanctioned countries in the world as of January 2023

Source: compiled by the author according to Statista ^[12]

The promotion of the euro and other currencies as a reserve asset with significant liquidity, the growing current account deficit and the US government debt encourage the central banks of countries to diversify international assets in the direction of reducing the share of the US dollar. The existing international monetary and financial system can be transformed, decisions on foreign investments will be made based on political rather than economic foundations ^[13], which must be taken into account when forming international reserve assets. Nevertheless, the use of the US dollar in over-the-counter turnover as a percentage of the average daily turnover has remained fairly stable over the past years, as shown in Figure 4.

Figure 4 – The share of currencies in the over-the-counter average daily turnover, in 2004-2022.

Source: compiled by the author according to the Bank for International Settlements ^[14]

Perhaps this is due to the presence of some concern that the decline and departure from reserve assets denominated in US dollars to assets denominated in euros and other reserve currencies may lead to a sharp depreciation of the US dollar, which in turn will have an impact on both the global economy and the national economies of the world, since a significant change in the structure of international reserve assets will have an impact on both exchange rates and the status of the US dollar as the dominant global currency, which in turn will have an impact on the international monetary and financial system. Also, in practice, in the case of a regulated exchange rate regime, the base currency is the currency or currencies to which the country's own currency is linked, and in this case, if countries begin to implement a strategy of moving away from the US dollar, this will also have a significant impact on both the US dollar and the global economy as a whole.

In addition to the above, it is believed that reserve assets denominated in US dollars have both high liquidity and low transaction costs, which can also be considered as factors of the dollar's dominance in the global monetary and financial system, but it is possible to solve the problem of transaction costs, including through the use of digital currencies of central banks.

As shown in Figure 4, on the one hand, the share of euros in foreign exchange settlements decreased, but on the other hand, the share of international debt securities denominated in euros remained generally stable, the share of euros in world reserve assets increased slightly, and in the issuance of international bonds, in international loans and in international deposits increased significantly. ^[15] Other indicators of the international role of the euro indicate that the euro remains a generally stable and attractive reserve asset, which is also confirmed by the share of the euro in the circulation of international debt securities, which remained unchanged, and the volume of international issuance of green bonds denominated in euros almost doubled to 41 billion euros in 2021.

Next, it seems appropriate to consider the SDR currency basket, which is essentially an international reserve asset based on a basket of five currencies — the US dollar, euro, Chinese yuan, Japanese yen and British pound sterling.

Table 1 – SDR currency basket, as a percentage

Source: compiled by the author according to the IMF ^[16]

            As Table 1 shows, the share of the euro in the SDR basket has changed over the past 20 years, but as a result, in 2022 it reached its original version, namely, 29.31 percent, which may be due to the implementation of fiscal and monetary policy by the European authorities in modern conditions of growing global inflation caused by higher costs for energy carriers and normalization of demand as the economy recovers. The share of the US dollar, in turn, tends to increase, if in 2000 the share of the US dollar in the SDR basket was 39 percent, then in 2022 it has already increased to 43.38 percent. The shares of other reserve currencies, such as the pound sterling and the Japanese yen, show a tendency to decrease their share in the SDR basket. It is important to note that in 2016, the Chinese yuan 10.92 percent appeared in the SDR basket, with a tendency to increase to 12.28 percent in 2022. In addition, it should be noted that a number of countries include the Chinese yuan in their international reserve assets.

            It seems appropriate to note the position of experts from the Eurasian Fund for Stabilization and Development (hereinafter referred to as the EFSR), who proposed creating a special "energy" currency for state reserves, and also developed about 11 instruments, from swap agreements to the use of cryptocurrencies, including so–called stablecoins, that is, digital coins tied to real assets, management of state reserves in modern geopolitical conditions, which essentially represents a change in the form of traditional financial assets: digital currencies, including digital currencies of central banks (Central Bank Digital Currency, CBDC, or CVCB), cryptocurrencies and tokenized assets. ^[17] The conceptual basis of the proposed reserve asset management system is the maximum diversification of the tools used and the involvement of several operators to manage reserves. ^[18]

conclusions

1.      Diversification of international reserve assets is an important direction of financial and economic policy, which allows reducing both the risks associated with reserves and volatility, including volatility in the financial market.

2.      When diversifying the structure of international reserves, it is necessary to take into account the goals: short, medium and long-term, as well as take into account the active, passive and stabilization diversification of international reserve assets.

3.       In modern geopolitical conditions, the role of the US dollar as a reserve asset is declining as countries are forced to look for an alternative to the US dollar, including in connection with the sanctions applied by the United States against various countries, including Russia. The use of the euro and other currencies as a reserve asset with significant liquidity, the growing current account deficit and the US government debt encourage the central banks of countries to diversify international assets in the direction of reducing the share of the US dollar.

4.      Indicators of the international role of the euro indicate that the euro remains a generally stable and attractive reserve asset, which is also confirmed by the share of the euro in the circulation of international debt securities, which remained unchanged, and the volume of international issuance of green bonds denominated in euros almost doubled to 41 billion euros in 2021. The share of the euro in the SDR basket in 2022 reached 29.31 percent, which also confirms the role of the euro in the international context.

5.      Diversification of international reserve assets, among other things, through the use of the euro single currency as one of the "poles" of the polycentric model of the world monetary and financial system, since, on the one hand, it allows to gradually reduce the share of the US dollar in reserve assets, and thus contribute to the transformation of the world monetary and financial system towards polycentrism, while at the same time, the replacement of the US dollar by increasing the share of the euro will preserve the liquidity of reserves since the euro is a freely convertible currency, and on the other hand, this diversification strategy will help reduce the imbalance of forces between Russia and the European Union, which consists in distortion, violation of the existing balance of interdependence and is in constant dynamics under the influence of various internal and external factors.

 THANKS

The article was prepared based on the results of research carried out at the expense of budgetary funds under the state assignment of the Financial University.