from Follow the Money

The euro/dollar, valuation losses and central bank reserves

July 13, 2005

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India, Thailand and Korea all have fewer reserves than they did at the end of March. At least in dollar terms. Their euros and euro-denominated bonds are not worth what they used to be.

Malaysia - which still intervenes on a large scale to keep its currency pegged to the dollar - is still adding to its reserves. But it is working against the headwind created by a $1.6 billion loss on its existing stock of reserves.

India’s reserves fell by about $4 billion in the second quarter, to $137.5 billion or so. That, incidentally, is close to the portfolio losses that India would have experienced if had 60% of its reserves in dollars, and 40% in euros or currencies that moved with the euro. India, of course, doesn’t hold all of its non-dollar reserves in euros. It, for example, may hold more than 40% of its reserves in currencies other than the dollar, but hold some currencies that fell by less than the euro did.

But there is little doubt that India has a relatively diverse portfolio of reserves assets. And this is not a new development. India experienced big valuation gains -- $7.8 billion from April 2003 to March 2005 - as the dollar fell against a range of other currencies. Check out the most recent report put out by India’s central bank.

Korea clearly holds some of its reserves in euros and other non-dollar reserve currencies. But it also clearly has less in euros than a country like India. Its reserves are bigger than India’s, but the value of its reserve portfolio fell by less. A 60/40 split for Korea would have produced valuation losses of over $5 billion. In reality, Korea’s reserves only fell by $1.8 billion from their mid-March peak. Draw your own conclusions.

I have been tracking the reserves of eleven major emerging market economies - the BRIC countries, Mexico, the Asian NICs, and Malaysia and Thailand. Collectively they account for about $2 trillion in reserves. Japan and the euro system hold, in ball park terms, another $1 trillion. And all other countries combine to hold another $0.8 trillion - producing a global total of around $3.8 trillion. That number comes from the of February -- it is probably above $4 trillion now. Which is to say that these countries’ reserve management decisions matter, they account for roughly half of the world’s central bank reserves. It is pretty clear that global reserve accumulation continues. These economies added $81 billion to their reserves in q2, assuming that China added $20 billion to its reserves in June (This total includes the $15b China transferred to a state bank). Adjusted for valuation losses, I estimate that the underlying pace of reserve accumulation in the second quarter was around $119.

That compares with $98 b in q1, $108b adjusted for valuation losses.

China accounted for about half of the total reserve accumulation of these economies in q1. By my estimates, it probably accounts for nearly 80% of the q2 total. In q1, Korea, Taiwan, Malaysia, Brazil, India and Russia all added significantly to their reserves. In q2, the only Russia made a substantial addition to its reserves -- Taiwan, Malaysia and Singapore added smaller amounts.

Put differently, China and Taiwan were the only non-oil exporters to add substantially to their reserves in the second quarter.

Looking ahead, it seems likely that more and more of the global increase in reserves - leaving Russia and China aside - will come from countries in the Middle East, not countries in Asia.

That makes my job a lot harder. Many countries in the Middle East are even less transparent than China. And I have not even tried to figure out the (changing?) currency composition of their reserves.

Obviously, I don’t know the currency composition of the reserve portfolios of major emerging economies either, and there are no guarantees my numbers are anywhere close to accurate. My valuation adjustments rely on educated guesses. Assuming that Malaysia’s non-dollar reserves moved in tandem with the euro (a huge assumption), Malaysia’s reported valuation losses, for example, are consistent with dollar reserves of somewhere between 55 and 70% of its portfolio, i.e. non-dollar holdings of between 30-45%. The biggest potential source of error: China. It is both the biggest holder of reserves and the biggest mystery.

In my base scenario is that these eleven emerging economies added about $240 billion to their reserves in the first half of 2005, and experienced - collectively - a valuation loss of a bit under $60 billion on their $500 billion or so (estimated) holdings of euros and currencies that moved in tandem with the euro. Afterall, the Euro started the year at 1.35.

That at least is one way to explain the $180 b or so (again, assuming $20 b from China in June) reported increase in the reserves of these emerging economies. My estimate implies that these eleven emerging economies collectively still hold about 75% of their reserves in dollars. If they collectively held more euros or currencies that moved in tandem with the euro at the beginning of q2, they then experienced larger valuation losses in q2 - and their underlying pace of reserve accumulation therefore must have been higher.

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