Central Bank Currency Composition and Financial Stability: Does Dollar Decline Matter?

Abstract

Background This study examines whether the accumulation of U.S. dollar (USD) reserves mitigates financial volatility in the presence of rising geopolitical risk (GPR) across emerging Asian economies. In the context of ongoing discussions on the changing currency composition of official reserves and renewed debates on de-dollarisation, the study evaluates whether a higher share of USD holdings dampens or amplifies the transmission of geopolitical shocks to foreign exchange (FX) markets. Methods Using balanced monthly panel data from 2020 to mid-2025 for eight major Asian economies - India, Indonesia, Vietnam, the Philippines, Malaysia, Thailand, China, and Pakistan - we adopted a two-stage empirical strategy. First, a fixed-effects panel regression with robust standard errors and an interaction term between the USD share and GPR index tests the moderating role of reserve composition on FX volatility. Second, wavelet coherence analysis explores the time-frequency co-movement between GPR and FX market volatility. Results The results show that GPR and USD ownership significantly influence FX volatility, whereas the interaction term is negative and statistically significant. This indicates that economies with larger USD reserves experience fewer exchange market disturbances during geopolitical tensions. Wavelet evidence further supports this moderating effect, especially during global shocks such as COVID-19 and the Russia-Ukraine conflict. Conclusions Overall, the findings reaffirm the continued relevance of the USD as a stabilizing anchor in reserve portfolios and provide policy guidance for central banks on reserve composition during periods of heightened geopolitical risk. This study contributes by integrating macro-financial risk analysis, reserve management, and time-frequency dynamics within a unified framework.