In emerging Asia, Forex reserves build confidence
Isabel Reynolds, Reuters, Tokyo
The huge foreign exchange reserves built up in Asia may eventually find more productive uses, but for now, after the 1997/98 currency crisis, many countries simply value the guarantee they provide, analysts said.
China, whose reserves totaled just over US$200 billion at the end of October, holds the second-largest pool in the world after Japan, or third-largest if the euro-zone countries are taken as a bloc.
Other Asian countries, such as Taiwan and South Korea, have built up foreign assets of more than $100 billion each.
Behind the build-up lies lingering unease over financial stability following the Asian crisis of 1997/98, since a deep pool of reserves can be a valuable asset in maintaining a country's credibility among foreign investors.
"Especially with emerging market currencies, the issue of credibility...is important in terms of encouraging people to buy your assets," said James Malcolm, currency analyst at JP Morgan.
But Junichi Mori, research manager at the Institute for International Monetary Affairs (IIMA) in Tokyo, expressed doubts about the usefulness of small countries holding very large amounts of reserves.
"For example, South Korea's reserves are building up very rapidly, though its economy is very small compared to that of Japan. Perhaps there is a more efficient way of using that money," he said.
However, transferring reserves back into the home currency is seen as impossible for exporting nations, because of the undesirable effect on exchange rates.
China's reserves could also be put to more effective use, said Suiyo Li, an economist at Nomura Research Institute.
"Reserves built up partly because of the positive balance of trade, but also because foreign direct investment (FDI) into China has increased in the last couple of years," Li said.
Last year's total FDI into China came to $40.8 billion and an even larger total is expected this year.
"It would really be better if the money was not just sitting there, but flowing through the economy, helping development," she said.
IIMA's Mori suggests the credibility effect of large forex reserves would be more efficiently achieved through agreements between Asian countries to support one another's currencies in times of crisis.
Several bilateral currency swap deals have been agreed between various Asian nations under the Chiang Mai Initiative, named after the northern Thai resort where it was agreed by finance ministers from 13 Asian countries last year.
One rule of thumb indicates that holding enough foreign currency to cover three months' imports is sufficient. China currently holds enough for around ten months, according to Li.
But she said China was in a delicate position, having yet to find out how its membership of the World Trade Organization from this month would affect its currency, currently traded in a very narrow band around 8.28 yuan to the dollar
"I think they will use the money in a more efficient way in the future, but they are uneasy at the moment. They are retaining the funds so as to be able to intervene," said Li.
She believes China's reserves will continue to grow, although the pace will slow as falling world growth hits its export markets over the next year at least.
In the meantime, China is at least moving to diversify its reserves holding, unlike Japan, whose reserves of $403.880 billion at the end of November are largely held in dollars.
Although currency breakdowns are considered a state secret in China, Li estimates from the make-up of China's foreign debt that around 70 percent of its reserves are held in dollars, about 15- 16 percent in Japanese yen and roughly five percent in euros.
On November 20, China announced it had raised the proportion of euros in its reserves and would continue to buy euros.
In the 1980s, the picture was very different, with around 50 percent of the total being held in yen, as China often issued bonds in the Japanese currency. Only 26-27 percent was in dollars at that time, according to Li's estimate.