Executive summary

Two decades ago, the US invaded Iraq, 10 nations joined the European Union, severe acute respiratory syndrome (Sars) broke out in China and spread across the world, and World Trade Organization-led negotiations between nations collapsed. The US dollar depreciated relative to the euro and other currencies, as the US called for China to loosen its exchange rate policy.

A global financial crisis, another pandemic and the sharpest monetary tightening cycle in over four decades later, the 20th edition of the HSBC Reserve Management Trends book brings together the views of 91 reserve managers on their outlook for 2024, as well as in-depth chapters on diversification, the renminbi, gold and the evolution of a new central bank investment policy.

Many reserve managers saw their foreign exchange reserves drop between 2020–22, and persistent inflation has made it difficult to preserve asset values. Looking forward, there are signs that efforts to address the climate crisis and sustainability objectives may be superseded as priorities this year, particularly among emerging market economies, as reserve managers prepare for possible currency interventions, as well as economic fallout from escalating geopolitical crises.

2024 survey findings

The first chapter presents the views of 91 reserve managers on the risks they face and strategies they employ. Following the eruption of the war in Gaza that threatens to destabilise the Middle East and Red Sea supply chains, globally, reserve managers voted geopolitical escalation their most pressing concern, and one that can trigger inflationary and energy shocks.

“The Israel-Hamas war, with the resulting attacks by the Houthi rebels on vessels passing through the Red Sea, can affect the global economic landscape and impact reserves,” said one official from a lower-middle income central bank in Africa. “Geopolitical escalation, in particular over Taiwan, could significantly impact global growth trajectories and supply chains,” agreed an official from a high income central bank in Europe.

Although no central banks in the Middle East voted geopolitical escalation as the top risk facing reserve managers in 2024, all respondents from the region said they incorporate it into their risk management and asset allocation decision-making.

Thirty central banks reported making at least one change to their reserve management as a result of geopolitical risks, most commonly to the location of investments, counterparties and currencies invested in. Twenty-five are considering making changes. The focus on geopolitical escalation marks a shift from last year, despite unprecedented sanctions on the Bank of Russia’s reserves due to the invasion of Ukraine in 2022.

Renminbi internationalisation

In the second chapter, on renminbi internationalisation by Paul Mackel, Joey Chew and Jingyang Chen, the authors argue that a rise in geopolitical risks has fostered the use of renminbi as an alternative currency for international payments, particularly for trade. After the US and its allies froze Russia’s foreign exchange reserves and barred Russian banks from the Swift messaging system, many banks in Russia converted some FX assets into renminbi assets, and replaced the New York-based Clearing House Interbank Payments System (Chips) with the renminbi Cross-border Interbank Payment System (CIPS) set up by the People’s Bank of China (PBoC). However, at the same time, the International Monetary Fund’s Currency composition of official foreign exchange reserves (Cofer) survey suggests that the Chinese currency’s share of global allocated reserves peaked at 2.83% in Q1 2022, and has reduced by 0.46 percentage points as of Q3 2023. This was the first time global central banks sold renminbi since the currency was included in the IMF’s special drawing rights (SDR) basket in 2016, the authors say.

Recently, China’s policy focus has shifted towards promoting the renminbi in bilateral trade settlement and in public-sector loans to developing economies. China has pushed through multiple trade agreements, signed the Regional Comprehensive Economic Partnership (RCEP), and reiterated its commitment to joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).

The government’s overseas lending portfolio, under the Belt and Road Initiative, used to be dominated by USD-denominated infrastructure project loans, but is “gradually shifting towards RMB-denominated emergency liquidity support” to financially distressed countries. China has also issued renminbi-denominated emergency loans to borrowers when they were facing difficulty repaying their dollar-denominated loans, as a way to ensure that its largest borrowers with USD-denominated debts to Chinese creditors do not exhaust their US dollar reserve holdings. “China’s willingness to serve as an international lender of last resort today is reminiscent of a similar role that the US played during the 1930s and after World War II,” say the authors.

For the renminbi to achieve a higher level of internationalisation, the authors suggest that deeper trade and financing links, as well as better infrastructure for RMB settlement, will be key. The PBoC is one of the four founding central banks for the Bank for International Settlements’ Project mBridge, which experiments with a multiple-central bank digital currency (CBDC) platform for cross-border payments and FX transactions. The e-CNY, China’s CBDC, has the potential to provide efficiency gains in cross-border payments.

Managing tides: Bank of Korea’s diversification strategy

In Chapter 3, Min Soo Kwon writes about the Bank of Korea’s diversification strategy – from the Asian financial crisis and the global financial crisis, to the present day and future challenges. All hold lessons for other reserve managers now. By the end of 2023, South Korea’s foreign reserves had surpassed $400 billion, meaning the BoK manages the ninth-largest foreign reserves in the world.

The BoK’s investment diversification approach can be divided into three phases: the period from the aftermath of the 1997 Asian financial crisis to the mid-2000s (1998–2004); from the mid-2000s to the global financial crisis (2004–08); and the aftermath of the global financial crisis up to the present (2009–2024).

After the Asian financial crisis, the BoK’s foreign reserves had fallen to $3.9 billion, but increased to $100 billion by 2001. As its reserves reached a level that allowed the country to recover from the “trauma of the crisis”, the BoK began to take on a new role as an asset manager, rather than operating solely as a monetary authority that manages emergency funds for use in times of crisis. At that time, twin deficits in the US, meaning both a fiscal deficit and a current account deficit, “raised concerns about the long-term sustainability of the US Treasury market”, the author says. As the Federal Reserve lowered its interest rates, which led to a significant drop in market interest rates, “global public investors started to reconsider their investment practices in dollar-denominated safe assets, and the BoK was no exception”. The BoK began to gradually expand its investment portfolio by investing in new financial products and by diversifying into new currencies.

In the second period, the BoK posted accounting deficits for four consecutive years, from 2004 to 2007, as the Korean won appreciated and domestic and foreign interest rate differentials widened, underscoring challenges in balance sheet management and “prompting a new perspective on investment diversification”. The BoK began to diversify into new products “in earnest” and significantly increased the size and proportion of its mortgage-backed securities and corporate bonds, “to secure profitability”. In addition, in 2007, the BoK began investing in equities, which was not common among central banks at the time. Diversification during this period was driven by both asset and liability considerations, as opposed to the explicit asset-only considerations of the previous period.

In the 2010s, the BoK searched for new investment opportunities within existing asset classes. Reserves surpassed $300 billion in 2011, driven by global liquidity expansion resulting from major countries’ quantitative easing measures. That year, the BoK expanded the scope of its external funds management to include emerging market equities. In 2013, in addition to the financial sector, the BoK started investing in non-financial corporate bonds and in European covered bonds. The BoK has been continuously increasing the size of its environmental, social and governance (ESG) investments since 2019, holding $19.6 billion in ESG assets as of 2023. Recently, corporate bond exchange-traded funds have been added to facilitate agile tactical positioning.

After losses at the Swiss National Bank

In Chapter 4, Jonas Stulz, the Swiss National Bank’s head of portfolio management and deputy head of asset management, sat down with editor-in-chief Christopher Jeffery for an interview on how the reserve management team has been navigating recent challenges.

“The primary objective of our investment policy is to support monetary policy at all times,” said Stulz. The SNB’s reserves increased sharply over the past decade, peaking at $1.1 trillion in January 2022. However, the SNB, “along with most other asset owners, recorded substantial losses in absolute terms” in 2022 and 2023, he said. In the SNB’s case, “we lost on equities, we lost on fixed income, and we lost on FX risk”.

Because the SNB marked-to-market its reserves portfolio in Swiss francs, it also suffered valuation loss, which accounted for another substantial part of the decrease, particularly in 2022. However, the central bank’s investment policy investment policy is driven by long-term considerations. Consequently, the SNB has made “no major” changes in its strategic asset allocation in response to the situation of 2022. The total portfolio’s duration is currently slightly below five years. “We tend to have longer duration than other central banks,” said Stulz.

Another reason for the SNB’s comparatively longer duration is that the SNB is fully invested in foreign currency, meaning it does not execute FX hedging, and reports its portfolio performance in Swiss francs, which is considered a ‘safe-haven’ currency.

“In this constellation, duration has historically been a very good portfolio diversifier” for the SNB, said Stulz. In a ‘risk-off’ environment, the SNB would suffer from losses on its FX exposure due to Swiss franc appreciation, but benefit from gains on duration due to decreasing global yields. And vice versa in a ‘risk-on’ environment.

“Obviously, this playbook does not work in every environment, such as in 2022. But, in the long term, we still believe duration is a good diversifier for our portfolio,” said Stulz.

The SNB has, however, been making some changes to its reserve management since 2018, by implementing a data-driven approach to fixed income trading. This initiative combines pre-trade analysis, execution and post-trade analyses into one integrated workflow, including feedback loops.

On the potential of AI, Stulz sees possible applications in portfolio analysis and management, as well as the trading. However, he asserted: “That’s music of the future.”

The evolution of the National Bank of Slovakia’s investment policy

Last year, the National Bank of Slovakia undertook a series of strategic decisions that “profoundly” influenced both structural and operational aspects of its reserve management, writes Michał Zajac in Chapter 5. Key among these decisions was the adoption of a new investment policy. The last time the NBS fundamentally revised its investment policy was at the time of the Slovak Republic’s entry into the eurozone, when the NBS found itself in the position of being the only central bank in the eurozone with negative equity. However, becoming a eurozone national central bank allowed for the construction of a multi-currency bond portfolio, focused on systematically collecting moderate credit and liquidity premiums, while adjusting the size of investment reserves depending on market conditions.

Gradual personnel changes in the NBS Bank Board, especially after 2018, led to a positive view of the NBS’s ability to function as a long-term investor. However, at the same time, gradual inclusion of new asset classes into investment reserves had revealed that the NBS “lacked a comprehensive and robust framework for asset allocation at a strategic level”. A review of the central bank’s investment strategy began in 2020, and the investment horizon of the central bank has “significantly evolved” from being largely short-term, with return expectations set on a one-year basis, to an investment horizon considered a “continuously renewing cycle”.

A longer investment horizon increases tolerance for return volatility, and the capacity to undertake investment risks in exchange for higher average risk premiums, says Zajac. The NBS’s new investment policy allows expansion of the types of risks that the central bank is willing to expose itself to, adding interest rate, equity market risk and currency risk to credit and liquidity risks. After several internal discussions within the NBS’s leadership and consultations with experts from the World Bank and European Central Bank, the view on negative equity also evolved such that it is no longer considered a limiting barrier to taking investment risks, and is not cause for “undue shortening” of the investment horizon. The new investment strategy also anticipates the development of two distinct reserve management frameworks: discretionary and benchmark-based. It envisages using the risk budget for active positioning against strategic and tactical benchmarks, as well for macro-overlay trades within discretionary portfolios.

The NBP’s gold purchases – a view from the risk management trenches

In Chapter 6, Paulina Domagalska, Juliusz Jabłecki, Maciej Pomykała and Navdeep Singh from the National Bank of Poland, explain the thinking and analysis of the central bank’s gold purchasing programme that has seen it buy around 256 tons over the past six years. The authors also trace the history of gold reserves at the NBP, which emerged from the post-Communist transition in the early 1990s with virtually no gold reserves. Following the 1939 invasion by the Nazis, the evacuation of Polish pre-World War II gold reserves – through Romania, Lebanon, France, the Sahel and ultimately to the UK, US and Canada – is still “vividly, if painfully, remembered”, since the entire stock saved from the war was shortly thereafter spent by the newly established Communist authorities.

A small stock of roughly 15 tons of gold was maintained throughout the 1990s, until eventually a decision was made that the FX reserves portfolio was large enough to allow a build-up of gold holdings. The thinking went that it could shore up foreign investors’ confidence in the zloty and potentially the broader economy. “The time was opportune”, the authors say, as a number of central banks in developed markets, which entered the era of great moderation with high gold reserves, began liquidating parts of their stocks. The purchases in the late 1990s brought the NBP’s gold holdings to roughly 100 tons, the vast majority of which were kept at the Bank of England.

By 2018, the NBP’s total foreign reserve assets had grown to over $113 billion, making the NBP confident that it “had enough latitude to start building up an allocation to the precious metal” that would see it “moving closer in line with averages seen among peers in Europe and across the world”.

In October 2018, the NBP purchased 25.7 tons of gold. The following year, the central bank followed suit with another round of purchases, this time to the tune of 100 tons, four times the target from the year before. Having concluded two rounds of gold purchases, the central bank entered “what will undoubtedly be remembered as one of the most challenging periods in the NBP’s history, marked by the successive waves of the Covid pandemic, Russia’s invasion of Ukraine and a considerable – if temporary – spike in both global and domestic inflation”.

Throughout this challenging time, the NBP’s gold investments “served us well”, say the authors, reaffirming the management board’s view that the central bank should continue expanding gold holdings. In the case of the NBP, an allocation to gold diversifies the risk associated with USD investments, “and does so in an asymmetric way”. It dampens the effects of PLN appreciation vis-à-vis the dollar, but improves mark-to-market valuation in periods of a weaker zloty. Hence, in 2023, the NBP’s dealers purchased an additional 130 tons of gold, which was deposited with the Federal Reserve Bank of New York, bringing the total stock to 358.7 tons, and just above a 10% share of the NBP’s overall reserve assets portfolio. In 2024, the Polish central bank’s management board passed a motion to increase to 20% the share of gold in the NBP’s official reserve assets. This would entail purchasing 226 tons of gold, as a result of which, the size of its gold reserves would increase to approximately 585 tons, making Poland the 11th largest holder of gold in the world and the 6th in Europe. This last project is currently under way.

On behalf of Central Banking Publications, I would like to sincerely thank all who contributed to this year’s book, both as authors and survey respondents. As ever, the editors welcome comments on this year’s book and suggestions for future editions.

We would like to express our thanks to Bernard Altschuler and his colleagues at HSBC for their continued support of this title.

Joasia E. Popowicz
London, April 2024