from Follow the Money

Asian central bank watch, last week of December edition

December 27, 2006

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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 reasons why central banks in India and Thailand decided to be more “scrooge” than “santa” this December are coming into clearer focus.

Take India.  Before the Reserve Bank of India (RBI) hiked bank reserve requirements (triggering an equity market sell off), Indian foreign currency reserves were rising rapidly.  They were up around $8b in November.    And not all that was valuation gains on India’s large euro and pound holdings – valuation explains maybe $3.5 of the increase, even if 50% of India’s reserves are in euros/ pounds.   The RBI was intervening to the tune of at least $1b a week.   

After the hike in reserve requirements, the Reserve Bank of India has been out of the market, more or less.  Reserves were stable in the first two weeks of December. (Data comes from the RBI’s weekly statistical supplement

Take Thailand.  Its central bank imposed inflow controls (triggering flight by investors who already had money in Thailand) after the pace of capital inflows picked up in early December and reportedly approached $1b a week.   That is a phenomenal sum for an economy the size of Thailand  … 

Take Korea.  The FT has reported that dealers believe Korea’s government spent $4b in the first three weeks of December fighting pressure for the won to appreciate, after reportedly spending $2b or so in November.   The Korean government is taking cues from the PBoC and talking tough as well.   Korea's Deputy Finance Minister recently said Korea is willing to buy dollars in near infinite quantities to resist further won appreciation.

 The FT again:

“To stabilise the economy, it is essential to maintain the currency at a certain level and the government will make its best efforts to achieve that,” Kim Sung-jin, a deputy finance minister, told KBS radio. “If the government consults with the central bank and intervenes in the currency market, our resources are unlimited,” Mr Kim said.

That sounds a bit like Japan in 2003/2004 or China now.  But Korea isn’t quite in the same position as the Chinese now or the Japanese in 2003/ early 2004 though. Korean interest rates are comparable to US rates, so sterilizing ongoing intervention is costly.   On the other hand, now that the won has appreciated significantly, it isn’t as obviously undervalued as say the yuan …. so Korea presumably has less exposure to future capital losses should the won rise relative to the dollar (remember, the central bank is selling won debt to finance the purchase of dollar debt, so it gains if the won falls/ loses if the won rises)

Take Taiwan.  It preemptively signaled that it is willing to intervene as needed to resist pressure for appreciation.

Call it the long shadow cast by an undervalued RMB. 

China’s shadow doesn’t extend to the Gulf.   Chinese manufactured goods don’t compete with the Gulf’s chief export.   Asia and the gulf are linked mostly because both regions are part of the dollar zone.

The UAE’s central bank is in the news today.  It announced that it plans to increase to raise its euro holdings from 2% of its reserves to 10% of its reserve by the end of q3 2007.  That isn’t a surprise.  It signaled that it was considering such a move last spring.  And since the UAE only has $25b or so of reserves, that involves a net sale of $2b dollars over the next three years.   China has to sell far more than that in average month (I suspect) to keep the dollar’s share of its reserves from rising. 

Moreover, the UAE’s central bank is the vehicle that manages most of the UAE’s petrodollars.  ADIA counts for far, far more.    The Saudi central bank (SAMA) by contrast, does have a lot of cash.   The government has deposited its considerable surplus with the central banks, pushing Saudi reserves (using reserves inclusively to include all of SAMA’s foreign assets) up substantially.  Total foreign assets have increased by $67b this year through November (Almost all of that has come from an increase in SAMA’s holdings of foreign securities).  SAMA’s foreign assets only increased by $3.5b in November though – an increase that is small by recent standards ($6-7b a month has been typical). 

The fact that Saudi reserves didn’t increase by much in November is significant for another reason: if it had lots of euros, its reserves should have increased significantly just because of changes in the dollar/ euro.  Look at Russia.  I am increasingly convinced that the Saudis have maintained a relatively high dollar share in their reserve portfolio.   That matters far more than small changes in the currency composition of the UAE’s reserves. 

Even if the UAE’s announcement that it has finally started to do what it said it was planning to do isn’t in and of itself all that significant, it is indicative of something that is important.  There are, I think, a fairly large number of central banks that have more dollars and fewer euros than they would like, and consequently, are looking to buy euros on “dips.”  

There aren’t many central banks who want to buy dollars on its dips.  But so long as many central banks peg their currency to the dollar or are in the same position as the Bank of Korea, they may not have much choice. 

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