from Follow the Money

Are the world’s oil exporters shifting away from the dollar?

December 10, 2006
6:34 pm (EST)

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The FT says so, drawing on work that from the Bank of International Settlements.

I like a good petrodollar story -- and a good central bank diversification story -- as much as the next guy.   A lot more than the next guy actually.

I would be somewhat cautious though.   Russia tends to drive the BIS data on oil exporters, as it now accounts for the majority of the growth in oil state deposits in the international banking system.   It turns out that only $5b of the $16b increase in international bank deposits by Russian residents (including Russia's central bank) in q2 were in dollars.  But we already more or less know Russia diversified its (now very large) reserves in q2.

There are a few intriguing hints that other OPEC countries may be diversifying in the BIS data as well.  Iran moved a decent chunk ($4b) of dollars out of BIS banks domiciled in europe -- but apparently didn't shift those dollars into euro.   Libya added to its offshore dollar holdings, offsetting the Iranian outflow.  And the Saudis (whose reserves didn't go up much in q2) shifted $3b from dollars on deposit in London to yen on deposit in London (all data comes from p. 3 of this chapter in the BIS quarterly).  The Saudi shift into yen is a small surprise ... I guess the Saudis front-ran the Russians and the Swiss. 

But the bigger story is that, setting Russia aside, the BIS data just isn't picking up a big net inflow from the oil exporters -- particularly oil exporters in the Gulf. 

Oil exporters in the emerging world are increasing their foreign assets by about $125b a quarter, with $25-30b coming from Russia and $50-60b coming from the Gulf.   Somewhere between 1/2 and 2/3s ($16b of $25-30b) of the increase in Russia's foreign assets showed up in the q2 BIS data, but nothing like a comparable share of the increase in the Gulf's foreign assets. 

The data on Russia's shift into euros and pounds isn't a surprise. Regular readers of RGE's Russian reserve watch (Warning: RGE premium subscription required) know that Russia started running down its holdings of US securities (mostly short-term Agencies) at the end of 2005 -- and that is has continued to reduce its US holdings throughout 2006.   The counterpart to the fall in Russia's US holdings has been a surge in Russia's deposits in the international banking system.

We now know that Russia shifted the currency composition of its reserves when it moved its reserves "offshore."   The BIS data basically confirms what the Russians told us in June, namely that they had reduced the dollar's share of their reserves to around 50%.

But I wouldn't look to the BIS data for great insight into what other OPEC countries (Libya excepted) is doing with its money.   Why not?  I have spent a fair amout of time trying to track down OPEC's surplus in general, and the GCC's surplus in particular.   Rachel Ziemba and I will have a paper out on this soon.  The big countries in the Gulf simply don't have that much money on deposits in BIS reporting banks and they certainly aren't increasing their (net) deposits in BIS banks.  

I don't want to downplay the BIS data too much though.  Even if the BIS story on the diversification of Russia's reserves is old news, it does highlight a potentially important development.  RGE premium subsribers (all ten of you) know that there was a surge in euro denominated deposits by central banks in the BIS banking data in q2 -- that was a key issue discussed in our most recent Global Reserve Watch.   

The increase in euro-denominated banking deposits in the BIS data (at least the preliminary q2 data) was a lot bigger than the increase in euro holdings that central banks reported to the IMF.  That alone isn't a surprise.   The BIS data and the IMF's data report on different things.  The BIS data -- table 5c specifically -- shows the currency composition of monetary authorities (that is a key point: neither SAFE or Japan's MOF count as monetary authorities) deposits in the international banking system.   It doesn't pick up the currency composition of central bank's securities.   The IMF data picks up the currency composition of both deposits and securities, but only for those central banks that report data on the currency composition of their reserves to the IMF.   A lot of countries -- including key countries like China -- don't report data to the IMF. 

So both the IMF COFER data and the BIS data have holes.  

However, the BIS data for q2 does provide some of the first evidence that central banks do not always act as stabilizing speculators.   Central banks increased their euro deposits when the dollar was under pressure in q2, adding to the pressure on the dollar.    Or at least one central bank was adding to the pressure on the dollar.

The possibility that Russia is driving the data isn't the only reason why I haven't pushed this story story all that hard.  

The overall data -- and it admittedly is incomplete -- still suggests to me that central banks are buying a lot more dollars (and somewhat fewer euros) in 2006 than they did in 2005.    

Let me explain.

In the first part of 2005 both the BIS and the IMF data showed an increase in euro and pound holdings.  That was an instance of stabilizing speculation -- central banks were increasing their euro holdings when the euro was under pressure, helping to support the euro.  



But what was a consistent story in the 2005 data is now a somewhat inconsistent story. 

The COFER data -- that is the data from those central banks that report to the IMF -- indicates that central banks increased their dollar purchases -- keeping the dollar's share of their reserves stable -- when the dollar came under pressure in the first half of 2006.  The lastest BIS data shows that central banks' euro deposits increased at roughly the same pace as their dollar deposits in q2 2006, when portfolio balance would have required faster growth in dollar than in euro reserves.  That may indicate a bit of diversification. Pound deposit growth was also quite high in q4 2005.

Alas, all this data is stale.  The key question is whether central banks are currently supporting the dollar -- or whether they are currently adding to pressure on the dollar.  

I would bet that they are still supporting the dollar.   But that is a guess.  

There was a rumor that the dollar didn't do better on Friday after the employment data because a big central bank was selling dollars.  Bloomberg:

``Some central bank came to the market to buy a bunch of euros at the level around $1.3250,'' said Firas Askari, head currency trader at BMO Capital Markets in Toronto. ``This really scared'' traders.

The fact that a central bank came to the market to buy euros on a small dollar uptick doesn't entirely surprise me.  Remember, a lot of central banks intervene in the dollar market: the dollar/ RMB -- and similar dollar/ local currency pairs -- is where most trading occurs.   And a lot of oil exporters get paid in dollars.  

To keep the dollar share of their portfolios from rising, those central banks whose reserves are growing month after month generally need to convert some fraction of their ongoing purchases -- and their ongoing oil payments -- into euros and pounds.  In normal market conditions, that isn't a problem.  But when the dollar is under pressure, I still suspect (but don't have the data to prove) that a lot of central banks find it difficult to sell some of the dollars they are buying in the market for euros and pounds.   If that's right, a lot of central banks -- not the least the PBoC and SAMA -- likely ended up November holding more dollars than they really want. 

That impliues that they are looking for opportunities to sell dollars for euros.  Not to diversify per se.  But to avoid further concentrating their portfolios in dollars.  At least that would be my guess.

The Russians are an exception.   They have clearly indicated that they don't want more than 50% of their portfolio to be in dollars.  And since they peg to a basket, I suspect that they have a bit more flexibility than those central banks that still peg primarily to the dollar. 

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