Asia may diversify reserves in face of global imbalance

Asia may diversify reserves in face of global imbalance

Agence France-Prese, Tokyo

South Korea's plan to diversify its huge holdings of U.S. dollar
assets highlights concerns that Asia needs to reduce its over
exposure to the dollar in the face of the global imbalances
caused by the massive U.S. current account and budget deficits.

Asian central banks are denying they are ready to reduce their
dollar assets given the risks of sparking a wholesale retreat out
of the U.S. currency which could have potentially disastrous
consequences in the shape of much higher U.S. interest rates.

At the same time, however, they have to face up to the fact
that these assets -- estimated to be well over a combined US$2
trillion -- could be a wasting asset if the dollar weakens under
the weight of the massive U.S. current account and budget
deficits.

Analysts say that everyone knows that the United States has to
remedy the deficit problem and that that probably involves a
lower dollar but no one is exactly sure how to get there without
totally upsetting the apple cart.

Reflecting the sensitivity of the issue, the dollar hit a one-
month low against the euro Tuesday on reports that South Korea,
which has the world's fourth largest forex reserves, planned to
cut its holdings of the U.S. currency.

The dollar later steadied at least on Wednesday after the Bank
of Korea issued a denial. Taiwan also felt obliged to follow suit
after reports that it too was going to sell down its US dollar
holdings.

The Bank of Korea said instead that it planned to diversify
its foreign reserves into non-state bonds but had no plans to
sell and convert dollar-denominated U.S. currency reserves into
other international currencies.

In practice, that means South Korea will likely decrease the
allocation of new reserves to the dollar, which will change the
overall dollar weighting, said Callum Henderson, head of forex
strategy at Standard Chartered Bank in Singapore.

Foreign reserve holdings in East Asia rose substantially in
2004 to around $2.3 trillion from $1.8 trillion, with China and
Japan accounting for three quarters of the gain, according to
Standard Chartered Bank.

"There has been a general trend in Asia and the Middle East to
look at, first of all, the issue of how to manage their
reserves," said Henderson.

"And secondly, what currency to consider if indeed they are
looking at diversification, pretty much focusing on the dollar
weight in new reserves rather than selling off their existing
reserves," he said.

However, too quick a move by Asian countries to diversify
their reserves could backfire, said Woo Chull Chung, resident
director general at the Asian Development Bank in Tokyo.

"If the dollar tumbles, it will reduce the value of their
dollar portfolios as well," he said. "They will perhaps do this
more gradually and in a more calculated way.

"Asia needs a better developed bond market, through which
large amounts of savings available in Asia can be channeled
within Asia to finance projects," Chung said.

"They have been dependent on the U.S. dollar bond market too
long and too much."

Naoyoshi Noguchi, director of the Asia Oceania division of the
overseas research department at the Japan External Trade
Organization (JETRO), said the Asian crisis of 1997-98 had
supported the idea that the region needed its own bond market.

"Asian countries want to support one another in case of a
crisis and that has led them to consider diversifying their
reserve currencies," he said.

Currently, the Asian countries are simply recycling their
trade and savings surpluses into U.S. dollar assets. As they do
so, they cover the U.S. current account and trade deficits and so
help keep U.S. interest rates at moderate levels in what has
become a closed circle but a potentially vicious one if it is
unwound.

"It's completely linked to the U.S. markets so if they hurt
the US markets, it will hurt their investment portfolios too,"
Noguchi said.

"That's why Asia wants to create a regional bond market to
keep the money from leaving for the U.S. ... it will be
problematic to sell dollar assets just because the U.S. economy
is slowing or the dollar is weaker," he said.

As for Japan, which holds the world's largest foreign reserves
of $841 billion at the end of January, its dollar-holding policy
is unlikely to change any time soon, analysts said.

"Japan is unlikely to adopt a policy of diversifying
currencies in its reserves for now because the finance ministry
would be too concerned about a plunge in the dollar against the
yen," said Tomoko Fujii, director on foreign exchange at Nikko
Citigroup Securities.

A weaker dollar would only cut Japanese export earnings at a
time when they are still the main driver for the country's
faltering economy.