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Countries are now more interested than ever in ensuring critical supplies. A shift toward localized production would reduce the demand for international currencies.
Meanwhile, lower reliance on any single trading partner might diversify demand for currencies. The recent conclusion of the Regional Comprehensive Economic Partnership in Asia – a free trade agreement between fifteen nation-states in the region – may signify a larger role for alternate currencies that currently account for a small share in international reserves.
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The credibility of the policies of debt-issuing countries is fundamental for trust in their currencies. The COVID-19 pandemic has highlighted the need for current and potential issuers to enact sound health and economic policies to preserve their growth potential.
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Corporate Sustainability
The shutdown in economic activity as a result of the COVID-19 crisis has resulted in a temporary decline in global carbon emissions, but the long-term impact of the pandemic on the transition to a low-carbon economy remains uncertain. On the one hand, the economic fallout from the crisis may constrain firms’ ability to invest in green projects, thus slowing down the transition. On the other hand, the pandemic could increase awareness of catastrophic risks and induce a structural shift in consumer and investor preferences toward environmentally friendly products, providing an opportunity to accelerate the transition. Looking back at previous episodes of financial and economic stress, this chapter finds that tighter financial constraints and adverse economic conditions are generally detrimental to firms’ environmental performance, setting it back by several years. This suggests that the COVID-19 crisis could potentially slow down the transition to a low-carbon economy. In light of the urgent need to reduce global greenhouse gas emissions, climate policies and green investment packages are needed to support a green recovery and the energy transition. Policies aimed at fostering sustainable finance, such as improved transparency and standardization, could further help alleviate firms’ financial constraints and mobilize green investments.
The future of reserve currencies
A number of economic and financial trends that could impact the future composition of reserve holdings. Geopolitical and technological developments might prove as significant as economic considerations, and, together with the current COVID-19 pandemic, could accelerate future transformations. Potential drivers of change include:
Shifts in international finance: the strong response to the European Commission’s large-scale bond issuance in October highlights potential demand for alternatives to dollar-denominated debt.
Emerging market and developing countries could also issue more debt in the currencies of emerging creditors, such as China, to help meet increased financing needs. Our paper finds that the currency denomination of public debt is an especially important determinant of emerging market and developing countries’ reserve holdings, likely reflecting central banks’ desire to hedge against risks associated with debt obligations.Changing trade links and invoicing practices could also alter demand for international currencies. Both the pandemic and recent trade tensions have highlighted the fragility of global supply chains.
New in Fintech
The financial industry is undergoing rapid technological change. Traditional banks face competition from online start-ups with no physical branches. Social media and other digital platforms are expanding into payments and credit. The increase in demand for digital services triggered by COVID-19 is turbo-charging this transformation. The confluence we are witnessing is driving fintech innovation and raises important questions. What are the transformative aspects of recent financial innovation that can uproot finance as we know it? Which new policy challenges will the transformation of finance bring?
The effects of digital transformation are powerful for the financial sector, already the industry most heavily reliant on computers. That is compounded by the doubling in use of online banking having in the past two decades in the European Union’s 15 largest economies. And with usage at 50 percent on average, it still has significant room to grow.
Superior technology platforms could also help new currencies overcome some of the advantages of incumbent currencies. Depending on the adoption and use of public or private digital money , central banks might have to rethink what constitutes, and how to hold, reserves going forward.