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    Asian Economy
     Mar 11, 2005
Dollar catching Asian flu
By Alan Boyd

SYDNEY - They may be telling a different story to money markets, but Asian central banks have been quietly switching their dollar holdings to regional currencies for at least three years, confirm global banking data. In a further, and so far the biggest, setback for the greenback's status as the undisputed reserve currency, Japan on Thursday said it might diversify its holdings, though monetary chiefs later sought to play down the prospect. South Korea rattled currency traders with a similar announcement late last month, followed by a similar backtrack.

China, India, Thailand, Indonesia, Taiwan, the Philippines and Hong Kong have already started a sell-off, despite a diplomatic show of solidarity for the greenback that is prudently designed to prevent a crisis of confidence in exchange systems. The likelihood is that much of this outflow will never return to US dollars as economic interdependence within East Asia and the widening shadow cast by China's trading conglomerates are slowly transforming the traditional market structure.

The Bank of International Settlements (BIS), which acts as a bank for the world's central banks, has just released a study showing that the ratio of dollar deposits held in Asian offshore reserves declined to 67% in September, down from 81% in the third quarter of 2001. India was the biggest seller, reducing its dollar assets from 68% of total reserves to just 43%. China, which directly links the yuan to the dollar and is under US pressure to allow a freer movement of its currency, trimmed the dollar share from 83% to 68%.

This shift conforms with global trends as central banks seek a buffer from the burgeoning US trade and budget deficits. A separate survey by European-based Central Banking Publications found that 29 of 65 nations surveyed were cutting back on the dollar and 39 were buying more euros. America's annual budget deficit of US$500 billion is largely funded by Asian purchases of US government bonds, mostly from China and Japan. The US trade and current account deficits are in a similar plight: it took $530 billion of foreign capital to finance US imports in 2003 and $650 billion last year. Projections for 2005 range up to $800 billion.

Export-led Asian central banks have been accumulating dollars for two decades or more to keep their own currencies competitive. Japan alone has stockpiled $841 billion of reserves to stop the yen from over-valuing as it searches for an economic stimulus. If the central banks pull out, the US may find it hard to borrow the cash it needs to keep the wheels of government turning. The conventional wisdom is that Asia is in too deep to quit, as to do so would invite huge exchange losses.

But some monetary chiefs have already decided there are greater risks in staying in bond markets as rock-bottom US interest rates - still only moderately above the 45-year low reached last year - have dragged yields to unappealing levels. China became a net seller of US government bonds in 2002, shifting much of its reserves to euros, Australian and Canadian dollars. Taiwan left the securities market in the same year and Hong Kong sharply reduced its exposure.

Currency market trading has also had a shift of emphasis, with China's yuan emerging as a potential regional substitute, albeit in the distant future. While this reflects the changing structure of East Asian trade, it is also an indicator of the increasing maturity of Asian exchange activity. According to the BIS data, turnover of the yuan in Asia has surged by 530% since the third quarter of 2001, compared with more restrained growth of 48% by the dollar, 49% by the euro and 93% by the pound sterling.

Trading in India's rupee grew by 114% in the same period and the yen registered 35% growth. The big losers were the Hong Kong dollar (21%) and the Singapore dollar (32%), reflecting the declining economic fundamentals of the two trading hubs. It is a similar picture with foreign exchange derivatives. Trading in yuan derivatives has soared by a staggering 272,355% in the past three years; next best was the Thai baht, with a growth of 2,858%. Dollar trading in derivatives rose by a mere 94% in this time, with euro trading up by 95%, pound trading by 126% and the yen trading by 58%.

The yuan data were calculated from a very low base in previous years and the BIS cautioned that the Chinese currency still had a miniscule influence on trade, due to tight domestic curbs on portfolio funds: it comprises only about 1% of the overall ratio of forex turnover to gross trade flows.

Movements in the dollar/yen spot rate remain the prime influence on Asian currencies and more than 90% of all external trade is still conducted directly in dollars. Only about 12% of holdings are believed to be in euros. Nonetheless, the yuan is converging with the yen and the Korean won and already exerts a strong pull on spot rates for the Hong Kong and Taiwan currencies, possibly hinting at a significant unrecorded trade in the Chinese currency.

While Asian currencies were expected to align themselves with US currency after the 1997-98 regional financial crisis in a de facto dollar bloc, the BIS said there is little evidence that this has occurred, despite the dollar links adopted by China and Malaysia. Rather, it appears that Asian currencies have become more elastic and their central bankers increasingly determined to pursue an independent course as financial markets gain greater depth and begin to more accurately mirror the region's importance to world trade.

However, it remains to be seen how much leash they will be given before being reined in by the nervous US Federal Reserve. The Bank of Korea, which has $200 billion of reserves and $69 billion of US Treasury debt, tentatively announced last month that some might be switched to other currencies, then quickly backtracked when the won surged to a seven-year high in global currency markets. The bank said the proposal, first floated in a parliamentary debate, was not a statement of intent.

Japanese Prime Minister Junichiro Koizumi triggered a similar frenzy after suggesting on Thursday that his country "in general" might need to make an "overall judgment" on diversifying its foreign reserves. The dollar had fallen to a nine-week low against the euro by the time a Finance Ministry official came out with a "clarification". It was merely a topic for discussion, not policy intent, he said. "We are taking a very cautious stance on how to manage foreign reserves, because the impact would be big," Finance Minister Sadakazu Tanigaki told reporters.

Big, indeed, as Japan has the largest dollar reserves in the world. Almost all Asian currencies surged vis-a-vis the dollar following Koizumi's unexpected statement. The Indian rupee rose to 43.56 in late morning deals, sharply higher than Wednesday's close of 43.64. The dollar went down against the Indonesian rupiah by 17 points at 12 noon on Thursday from Wednesday's closing value of 9,375.00, while the South Korean won went up by 0.1% against the dollar, provoking the Ministry of Finance and Economy to say that it was contemplating to intervene in the foreign exchange market.

Alan Boyd, now based in Sydney, has reported on Asia for more than two decades.

(Copyright 2005 Asia Times Online Ltd. All rights reserved. Please contact us for information on sales, syndication and republishing .)



For a few dollars less (Feb 26, '05)

Central banks dump dollar for euro (Jan 27, '05)

Japan's woes rise with the yen (Dec 11, '05)

Crisis towers over the dollar (Nov 25, '04)
Dollar drops: Good news and bad (Nov 25, '04)

Ominous: The US deficit vs the dollar (Oct 14, '04)

 
 

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