FYI | Jan 15 2007
By Chris Shaw
One flow through impact from nations such as China and the oil exporting nations running huge trade surpluses is an increase in their reserves of foreign exchange, which is largely held in US dollars given the greenback is the central currency in terms of world trade.
As Morgan Stanley notes, the total stock of global reserves has grown rapidly in recent years, with 2006 estimates showing an increase of around US$600 billion. The broker estimates total currency reserves now stand at around US$4.868 billion, with approximately two-thirds of this held in the Asian region.
China is leading the way, its total reserves estimated at US$230 billion at the end of 2006, up from US$200 billion at the end of 2005. Japan also recorded solid gains, with an increase in reserves of an estimated US$40 billion last year.
Helping the increase is a trend towards investing the surplus holdings into assets offering better returns such as equities and non-G3 markets, the broker calculating annual returns on holdings last year reached 4.4%. It sees this trend continuing to gain in importance as the level of holdings increase and the amount of intervention in currency markets falls.
In the broker’s view, only the People’s Bank of China and the oil exporters are likely to intervene aggressively in the forex market this year, though even their level of activity is expected to decline over the course of the year.
With the size of reserves increasing central banks have increasingly talked up the need to diversify their holdings away from the US dollar given its dominance in terms of total reserves being held. The central banks of Venezuela, Iran and the United Arab Emirates have all revealed their intention to diversify into the euro in coming months, which has put some pressure on the US dollar.
Morgan Stanley suggests moves by these smaller banks should have little impact given their reserve holdings are relatively small. It sees the Russian central bank as the one to watch, as it is estimated to hold as much as US$200 billion in foreign currency reserves.
The broker’s analysis of reserve holdings has identified some trends, so those involved in currency markets would be well advised to follow news out of the central banks of China, Japan, Russia and the major oil exporting nations, as their intentions regarding their level of US dollar reserves and possible moves to diversify these holdings will potentially impact on currency markets this year.