A chance to replenish reserves

BUSINESS ANALYSIS

Rosalind Mathieson

THE recent slide in the US dollar against Asian currencies provides central banks in the region with the opportunity to do some quick replenishing of their foreign exchange reserves.

Buying the US dollar now means central banks can put some gas back in the tank for what could be a dollar renewal in the later part of the year — which may require the authorities in Asia to then sell the greenback to protect their local currencies.

And, of course, US dollar buying right now fulfils another aim, namely to keep a lid on emerging market Asian currencies in order to rekindle export demand.

There is the perception that foreign exchange reserves in Asia have been badly run down in the past year or so. Reserves are actually not as low as some people might think, but they have certainly been depleted by the heavy volatility in currency markets and the ongoing presence of a large speculative contingent.

Indeed, HSBC currency strategist Daniel Hui in a recent report estimated that regional reserves, ex-China, have fallen by a fifth in the past year.

Some central banks are already stepping up their US dollar buying, with those in South Korea, Hong Kong and Thailand spotted of late. The Monetary Authority of Singapore is also likely to have been keeping a lid on the Singapore dollar in order to maintain the currency's undisclosed price band.

US dollar weakness may persist in the near term for several reasons. One is that concerns have been brought front-and-centre of late about the US fiscal position, and the heavy amount of debt being taken onto the government's books.

Another is that some of the data from Asia have been showing a bit of resilience — though the emphasis there should be on the "bit" — and this, coupled with a rise in stock markets, has stoked a measure of risk appetite. Inflows have risen to emerging markets, pushing up stocks and currencies alike.

But central banks will want to avoid that going too far. Financial markets and economies alike are still very vulnerable, the recovery indicators are patchy and mild, and for some there is still the sense the worst is it not over for Asia or Europe.

So buying the US dollar now has a dual impact. It prevents Asian currencies from rising too quickly, and it allows central banks to put more ammunition in their arsenals should there be further economic or financial headwinds ahead.

Asian central banks are notoriously paranoid about depleting their reserves, having worked so hard to build them up since the previous financial crisis. They are very keen to make sure the coffers don't get whittled down again. That means "smoothing" operations to buy the greenback are likely to continue, and intervention could pick up in the coming months across Asia as a whole.

That should leave traders a little wary about pushing Asian currencies too high in the near term. The gains are momentum-based, not structural. Dow Jones

From TODAYOnline.com, Business – Wednesday, 27-May-2009; see the source article here.

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