Key Takeaways
- We expect the share of the world's official foreign exchange reserves that is denominated in the Canadian dollar will continue to rise.
- The Canadian dollar also represents a growing percentage of global foreign exchange turnover, and this growth has been among the strongest of all currencies of 'AAA' rated sovereigns over the past decade.
- The growth in the use of the Canadian dollar is supportive of the 'AAA' sovereign rating.
We expect that within the small pool of sovereigns we rate 'AAA', Canada will maintain its unique position as a sovereign that controls its own currency, does not have to coordinate its policies within a monetary union, and has a currency with a rising share of the world's official foreign exchange reserves (see chart 1) and global foreign exchange turnover. These factors are all supportive of our rating on Canada.
Chart 1
The 'AAA' rating makes Canada one of only 11 'AAA' rated sovereigns out of 137 sovereign governments rated by S&P Global Ratings as of Aug. 31, 2024 (see table 1).
Table 1
| Sovereigns rated ‘AAA’ as of Aug. 31, 2024 (long-term foreign currency issuer credit ratings) | ||
|---|---|---|
| Canada | ||
| Australia | ||
| Denmark | ||
| Germany | ||
| Liechtenstein | ||
| Luxembourg | ||
| Netherlands | ||
| Norway | ||
| Singapore | ||
| Sweden | ||
| Switzerland | ||
| Source: S&P Global Ratings. | ||
Within this group, Canada is one of only five sovereigns that controls its own currency and does not have to coordinate its policies within a monetary union. Of those five sovereigns, we believe Canada's position is unique in that its currency represents the highest share in which the world's official foreign exchange reserves are denominated. This share has been increasing over the past 12 years, and S&P Global Ratings expects that it will continue to rise steadily. Within this group, the Canadian dollar also represents the highest share of global foreign exchange turnover, together with the Australian dollar. However, although the Australian dollar's share has decreased steadily in the past 10 years, the Canadian dollar's share has increased (see chart 2).
Chart 2
Growing demand for, and use of, the Canadian dollar in foreign exchange reserves and international financial transactions could support the international appetite for Canada's debt and make it less vulnerable to shifts in investors' portfolios of cross-border holdings than other countries. As investors use the Canadian dollar more frequently in international transactions, we believe they would be less likely to sell off assets denominated in that currency during periods of economic stress. At the same time, Canada's control of an actively traded currency allows the country to more easily use monetary policy to address imbalances or shocks in the domestic economy and facilitates the Bank of Canada's (BoC) ability to conduct monetary policy, in our view. S&P Global Ratings believes the control of a reserve or actively traded currency provides the BoC with more policy flexibility, as higher international demand for the Canadian dollar limits the risks of disorderly price movements or stalled trading during periods of stress and also can facilitate central bank balance sheet expansion when necessary.
In our view, the increasing importance of the Canadian dollar is likely supported by the global credibility of Canadian government policies and institutions over several decades and through growing geopolitical uncertainty, the strength of the financial system through successive economic upheavals, and Canada's large and open capital markets. At the same time, the Canadian dollar's widening importance has occurred alongside a gradual decline in the U.S. dollar's share of the world's official foreign exchange reserves and a rise in the share of what the International Monetary Fund calls nontraditional reserve currencies, a category that includes the Canadian dollar. In addition to the Canadian dollar, this category includes the Australian dollar, the Chinese renminbi, the Nordic currencies, the Singaporean dollar, and the South Korean won.
As we have noted before (see "Four Checkpoints On The Path To Greater Renminbi Internationalization," published July 10, 2023, on RatingsDirect), past global events, including the 2008-2009 Great Recession, have highlighted the risks of global reserves and payments systems being concentrated in their exposure to the U.S. In addition, the 2010-2011 European debt crisis trimmed the use of the euro in global settlements. These experiences have contributed to an increasingly diversified global monetary system. However, although the share of Chinese renminbi in global reserve assets has fallen over the past three years, the Canadian dollar's share has grown. The Canadian dollar now represents the fifth-most-used currency in the world for foreign official reserves, after the U.S. dollar, the euro, the Japanese yen, and the pound. Yet, its share (2.6%) is significantly lower than the shares of the other four currencies (58.9%, 19.7%, 5.7%, and 4.9%, respectively) as of first-quarter 2024. Nevertheless, the Canadian dollar has continued to increase its share while others, like the U.S. dollar, the euro, and the yen, have seen their shares decrease.
The strength, credibility, and independence of Canada's monetary policy, which support the demand for the Canadian dollar, also factor significantly in determining the 'AAA' rating and positioning the country as one of five 'AAA' rated sovereigns that carry the strongest monetary assessment (see chart 3). A differentiating factor between Canada and some 'AAA' rated sovereigns with a lower monetary assessment is that many of those with a lower assessment must coordinate their policies within a monetary union. Canada, on the other hand, can design its policy directly to manage domestic economic conditions. The Canadian government has used this flexibility in responding to past events to mitigate economic volatility.
Chart 3
In addition to Canada having the strongest monetary assessment, we believe its strong institutional and economic profile means the country will remain well positioned in the 'AAA' category over the forecast horizon (see chart 4).
Chart 4
We expect Canada's economy will keep expanding and will pick up speed over the next two years as fixed investment in the country is spurred by the BoC's monetary easing cycle that began in June 2024 (see "Economic Outlook Canada Q4 2024: Further Rate Cuts Will Accelerate Growth," Sept.24, 2024). At the same time, we believe inflation will continue to moderate, which will support the BoC's decision to continue to cut its policy rate through next year to reach its long-run nominal neutral rate, following the 75 basis points of cuts to date this year. The interest rate differential between the U.S. and Canada is narrowing following the Federal Reserve's decision to begin its easing cycle this month, which could lead to some strengthening of the Canadian dollar. Yet, regardless of temporary movements, we do not anticipate that any near-term changes to differentials will affect long-term demand for the Canadian dollar in global official foreign exchange reserves or sustained impact in the share of global foreign exchange market turnover, both of which we expect to continue to strengthen over the long-term. We anticipate that this strengthening will continue to support S&P Global Ratings' 'AAA' sovereign rating on Canada.
Related Research
- Canada, April 25, 2024
- How Does Canada Stack Up Against Other ‘AAA’ Rated Sovereigns?, July 12, 2021
This report does not constitute a rating action.
| Primary Credit Analyst: | Julia L Smith, Toronto + (416) 507-3236; Julia.Smith@spglobal.com |
| Secondary Contact: | Jennifer Love, CFA, Toronto + 1 (416) 507 3285; jennifer.love@spglobal.com |
| Research Contributor: | Ashay Gokhale, CRISIL Global Analytical Center, an S&P affiliate, Mumbai |
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