The global total dropped to US$11.6 trillion at the end of September, falling below US$12 trillion for the first time since March 2020, according to the International Monetary Fund.
“It likely reflects countries selling reserves, mainly dollars, to prop up their own currencies,” said Yoshimasa Maruyama at SMBC Nikko Securities.
Japan’s reserves fell 13% on the year to US$1.23 trillion at the end of 2022, the first drop in six years and the steepest in comparable data going back to 2001, according to government statistics released Wednesday. As the yen weakened sharply in September and October, at one point sinking beyond 151 to the dollar, Tokyo sold dollar-denominated assets for yen to try to stem its fall.
These drawdowns sap an important source of funds not only for such interventions, but also for repaying foreign-currency debt, and may leave countries more vulnerable to economic turmoil. Although currency markets have settled down for now, the risk remains of another spike in the dollar that could send countries scrambling again.
Faring especially poorly were emerging economies like Sri Lanka, whose reserves plunged more than 40% between the end of 2021 and November, according to IMF data, as a drop-off in tourism contributed to a dire shortage of foreign currency. Resource-poor Asian countries also saw sizable declines, with South Korea’s reserves dropping 10% amid efforts to shore up the won.
The trend has started to change in some countries as the dollar’s appreciation has eased over the past few months.
Turkey’s foreign currency reserves, for example, had dropped dramatically as President Recep Tayyip Erdogan’s insistence on keeping monetary policy loose drove down the lira. Once the pressure on the currency eased, however, the country actively worked to replenish these assets and ended up with a higher total than at the end of 2021. South Africa has built up its reserves as well.
But reserves in much of the world remain at worryingly low levels based on the IMF’s assessment of reserve adequacy (ARA) metric, which looks at whether countries have enough foreign currency on hand to cover potential drains.
According to Japan’s Dai-ichi Life Research Institute, Turkey now has only 53% of the reserves it needs under this measure – well below the IMF’s recommendation of 100% to 150%.
China, which has the world’s largest foreign currency reserves, stands at about 60% of its ARA metric after a 4% decline in its holdings from the 2021 year-end and November, suggesting it remains vulnerable to capital flight.
There is speculation that the US Federal Reserve could begin cutting interest rates again as early as this year, which would stem the upward pressure on the dollar. But the greenback could pick up steam again if inflation lasts longer than anticipated.
“The worst is over compared with when the dollar’s strength peaked last fall, but if it appreciates again, countries will have limited wherewithal to support their currencies,” said Toru Nishihama at Dai-ichi Life Research.