In emerging Asia, Forex reserves build confidence

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.