DEFINITION of Currency Internationalization

Currency internationalization is the widespread use of a currency outside the borders of its country of issue. The level of currency internationalization for a currency is determined by the demand other countries have for that currency. Such currencies will also tend to be held as reserve currencies.

BREAKING DOWN Currency Internationalization

An important facet of currency internationalization is that the currency concerned is not used only in transactions with residents of that country but also in transactions between non-residents; that is, non-residents use it instead of their own national currencies, whether transacting in goods, services or financial assets.

The Bank for International Settlements (BIS) highlights some important characteristics that need to be in place for internationalization. The most critical is that the government of the issuing country has no restrictions on purchase or sale of that currency by any entity. Secondly, exporters, whether from the country concerned or others, must be able to invoice their exports in that currency — for example, in 2007, 72% of Asian exports to Japan were denominated in U.S. dollars (USD), rather than in either the exporters' national currencies or Japanese yen (JPY). Of course, many commodities are also priced internationally in dollars.

Third, a range of entities including private and official companies and banks as well as individuals, should be able to hold the amounts they desire. If enough is held by foreign central banks, then the currency will become a reserve currency. The most dominant reserve currency is the USD (around 63% of the total at end-2017), with the euro (EUR) a distant second (around 20%). No other currency was more than 5% of the total. Finally, both domestic and foreign firms and institutions should be able to issue marketable instruments in that country's currency, irrespective of place of issue. For example, a eurobond may be sold by an emerging market to European investors but be denominated in USD; or an American company may issue a dollar bond in Asia.

Benefits of Currency Internationalization

There are a number of benefits to a country whose currency is internationalized. It provides more certainty to residents, who can denominate foreign transactions in their home currency. They can also borrow in foreign markets without incurring exchange rate risk, potentially enabling them to find cheaper funding. In general, the underpinned demand for the currency should dampen interest rates and thus help lower the domestic cost of capital. While a potential cost of internationalization could be destabilizing effects if a foreign loss of confidence were to lead to a sell-off in assets denominated in the currency, both the USD and EUR have large domestic debt markets that could act as a shock absorber in such a scenario.