from Follow the Money

Another month, another $10b (or more)

May 5, 2007

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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The $10b a month club came through in April. 

Brazil’s reserves: up $12.3b in April. Bacen also did a $3b reverse currency swap – its largest ever – last week.   It isn’t just intervening in the spot market.

Russia’s reserves: up an incredible $30.3b in April.  Maybe $4b of that comes from “valuation gains”; it is mostly real.

India’s reserves:  up $5b or so in April, with a bit over $2b of that from “valuation gains.”  And India has scaled back its intervention, big time, after the huge blow-out in its reserves in February.  The rupee is up sharply.

We won’t know much about China’s April reserve growth for a long time, but Jon Anderson of UBS notes that the pace of sterilization suggests that the strong pace of reserve growth in the first quarter continued.    Remember, the first quarter was really big – over $40b a month on average.

The second division of reserve accumulation held their own as well. 

Korea’s reserves were up $3.35b in April. Some of its “investment profits” may stem from the currency market – the BoK is high on my watch list for central banks that may be diversifying. 

Saudi Arabia won’t report its April reserves for a while.  But Saudi's March reserve growth was strong, as oil prices rebounded.

There is another bit of data suggesting strong reserve growth: the growth in central bank custodial holdings at the New York Fed.   Those custodial holdings rose $47b between March 28th and the latest data release (which picks up a few days in May).    That is in line with the $42.5b average monthly growth in the first quarter.    Big bucks.  Big flows.

I find it surprising that so many analysts still talk of the emerging world’s embrace of floating rates.   Floating rates are a bit hard to square with record levels of intervention.

The emerging world seems to have embraced undervalued exchange rates -– or at least exchange rates that currently can only be maintained with massive intervention -- far more than floating rates.

Simon Derrick of Bank of New York seems – to me – to have it right.    Reserve growth has picked up enormously in the emerging world over the past few quarters.   And the gap between the policies of the US and Europe –they now intervene far less than they used to – and the policies of the emerging world – which now intervenes more than ever – has grown.    Globalization here hasn’t brought policy convergence.

Mansoor Mohi-Uddin of UBS argues – as John Authers reports – that a surge in Chinese and Russian reserves an associated surge of Russian and Chinese sales of dollars for euros and pounds as both sought to hit their portfolio targets explains some recent euro and pound strength. 

Maybe.  

There is certainly reason to think that Russia’s very strong recent reserve growth will slow once the Yukos auction ends.  And since Russia has a low dollar share in its reserves, that should slow Russia’s need to sell dollar’s for euros.    But even so, I can see an argument why private capital might prefer rubles to dollars, so I am not sure all the inflows are Yukos related either.

However, I don’t think China’s reserve growth is likely to slow (especially if you include the state investment fund).   Sure, a lot of one-off factors contributed to the strong q1 increase – including the expiry of some swaps and perhaps the repatriation of offshore IPO proceeds.   But China’s trade surplus is typically rather small in the first quarter as well.  Consequently, I suspect that over the course of the year, the one-offs that pushed up China’s q1 reserve growth will fade – but the ongoing rise in China’s trade surplus will keep reserve growth very strong. 

I might suggest one modification to Mansoor Mohi-Uddin argument.  

Shifting dollars from the banks to the central bank shouldn't necessarily lead to any net additional dollar sales.  Wen state banks moved dollars back to the central bank, China in some sense wasn't buying any new dollars.   

On the other hand, China’s banks likely hold most of their foreign assets in dollars.    They did swaps with the central bank in dollars I think, and they presumably don’t want additional exchange rate risk.     China’s central bank, by contrast, likely has somewhere (my estimate) between 70 and 75% of its reserves in dollars.   Moving money from the banks to the central bank consequently could lead to a higher level of dollar sales.   

That matters, because I don’t think all of China’s hidden reserves materialized in the first quarter.

If Russia has a 50/50 dollar/ European currencies portfolio (the oil fund is 45% dollars/ 45% euros/ 10% pounds I think, but the rest of Russia’s reserves may have a slightly different currency composition – and I wanted to  keep the math easy), the rise in Russia’s reserves from $300b or so at the beginning of the year to $370b or so now required that Russia add about $35b to its dollar portfolio, and around euro 22b (a bit less) to its euro portfolio.   If Russia intervenes exclusively in dollars and gets paid for its oil in dollars, that requires buying about $30b (at April prices) of euros and pounds in the market. 

Note that the euro and pound “flow” addition to Russia’s reserves are smaller than the flow addition to Russia’s dollar reserves.  That reflects the impact of the rising dollar value of Russia’s existing euros and pounds in a “constant portfolio share” model.     China’s reserves went from around $1070 to $1200b in the first quarter.    Keeping a 70/30 portfolio would require adding $90b to its dollar reserves, bringing the total up from $750 to $840b, and adding a bit over euro 20b euros/ pounds ($27b dollars at the end march exchange rate) to its euro and pound portfolio.   April would require more dollar sales.

I left Brazil out because its reserves are mostly in dollars.  We know what it is doing.

UBS figures that Russia and China made these sales – over $60b in sales counting any reasonable estimate for China in April, and those sales will wane as Russian and Chinese reserve growth slows. 

That is one possibility.   UBS sees a lot of flows.

But there is another possibility.  Maybe Russia and China were not able to sell quite enough dollars for euros or pounds to keep the dollar share of their portfolio from rising.  

Russia probably did sell what it needed to sell.  The Russians aren’t very keen on the dollar.

But China might not have wanted to put additional pressure on the dollar.  Remember, dollar weakness means RMB weakness unless China changes its policy. The UBS story suggests central bank dollar selling will fall off.   

A story where central banks weren’t able to sell enough dollars to keep the dollar share of their portfolio from rising suggests central banks are currently holding more dollars than they want.  It consequently implies that they are looking to sell some of the dollars they bought in q1 -- not just some of the dollars they are buying now --into any sign of dollar strength.

At this stage, I don't think we know enough to know which of these stories better fits the data.  If anyone has a good sense of the magnitude of central bank dollar sales in q1, do tell!

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