Inclusion in SDR Does Not Spur Official Demand for the Yuan

The inclusion of the Chinese yuan in the SDR basket at the start of Q4 16 did not appear to prompt central banks to include it in their reserves. The latest IMF COFER report showed that as of the end of 2016, the dollar value of the yuan in held in reserves was $84.5 bln, which is in line with estimates of both private and public sector economists prior to the inclusion.  

This report is the first that breaks out the yuan from the "others" category that the IMF uses. The yuan accounts for a little more than 1.0% of the reserves for which the currency allocation is provided. Allocated reserves accounted for 73.2% or $7.9 trillion of the $10.79 trillion stockpile central banks amassed.  

Not all central banks provide the allocation of their currency reserves. China has begun gradually reporting the allocation of its reserves, and that is an important change that has been taking place. Over the course of 2016, the dollar value of unallocated reserves fell $1.211 trillion to $2.893 trillion. The total value of reserves (allocated plus unallocated) fell by $128 bln.  

The gradual allocation of Chinese reserves is one of several factors that is driving investors' understanding of reserve holdings. Central banks may change the allocation of reserves. This is what many market participants get caught up with, but it typically happens at glacial speeds meaning that often the changes are overwhelmed by more volatile variables, like valuation swings and whether reserves are being accumulated or liquidated.  

The dollar rose against the other reserve currencies in the Q4 16, and some of the moves were quite sharp. The greenback appreciated nearly 13.5% against the yen in the last three months of 2016. It gains almost half has much against the euro, 6% against the Australian dollar, and 5% against sterling.  

However, to minimize the short-term fluctuations and to see larger patterns, we focus now on year-over-year changes. The net valuation change in most of the reserve currencies was within plus/minus 3%. The euro stretched with a 3.2% decline, but sterling was the real exception. It fell 16.25%.    

The dollar holdings are not subject to valuation shifts. They rose $679 bln in 2016. However, as a share of allocated reserves, the dollar slipped to 63.95% from 64.16%.  The euro's share was constant at 19.73%. To remain steady in the face of the increase of allocated reserves and the decline in the foreign exchange market, the euro must have been accumulated. Its valuation rose $214 bln.  

The yen's share of allocated reserves edged higher in 2016 to 4.21% from 4.03%. The dollar value rose to $332.77 from $274.77. Of this $58 bln increase, about $7.7 bln can be accounted for by the yen's 2.8% appreciation. The remainder is accounted for by China's declarations or new purchases of yen.  

Sterling's share of allocated reserves fell from 4.86% at the end of 2015 to 4.42% at the end of last year. The dollar value of reserves allocated to sterling increased by $17.95 bln, but sterling's 16.25% decline would have drained $5.4 bln. Between China and other central banks trying to maintain a fixed allocation to sterling likely played the decisive role.  

The Australian dollar's share of global reserves eased to 1.85% from 1.92%, while the Canadian dollar's share edged up to 2.04% from 1.87%. We note that Canadian dollar appreciated almost 3% against the dollar in 2016, while the Australian dollar eased almost 1.1%. The US dollar valuation of the Australian dollar in reserves rose $15.1 bln to $146.1 bln. The US dollar valuation of Canadian dollar holdings rose $33.2 bln to $160.8 bln,

The use of the Swiss franc as a reserve asset has diminished. It was hardly a significant reserve currency but the negative interest rates that still go out a decade likely discourage reserve managers. The franc's share of reserves fell from 0.29% of allocated reserves to 0.17% last year. This represented a $6.0 bln decrease in the dollar valuation to $13.7 bln.  

The yuan share surpasses the franc's share easily, and it remains an open question how fast it explores it upside potential. We suspect that central banks will be cautious and opportunistic. China's onshore bond market is accessible, but there may still be liquidity concerns, and, as a store of value, there may be open questions. In the near-term, the risks are on the downside of the yuan and Chinese bond prices.  

Let us conclude with a word about the IMF's "other" category of currencies. With the yuan being taken out, one reasonably might have expected a corresponding decline in this category. However, the decline was more modest $12.2 bln. At the end of 2016, reserves in currencies not broken out by the IMF had a dollar value of $201.2 bln or 2.55% of allocated reserves. At the end of 2015, the "others" were worth $213.3 bln or 3.13% of allocated reserves. What is going on? We suspect that the results may reflect that China holds some "other" currencies in reserves, like the Singapore dollar, South Korean won. Some central banks may also have an allocation to Russian rouble, which appreciated 20% against the dollar in 2016.