Sterling reserves spark debate
Posted on » Saturday, July 04, 2009
LONDON: If the explosion in global foreign exchange reserves over the past decade is finally over then some western countries that reaped the unexpected windfalls -- such as Britain - may mourn its passing.
The debate about the size and make-up of the almost $6.5 trillion of hard currency reserves stockpiled in the world's central banks is evergreen; the position of dollar as the primary reserve currency a source of endless conjecture.
But the debate also extends to how far the quadrupling of world reserves over the past decade has benefitted the British pound, despite its relatively marginal role in reserve pools.
With reserve holdings typically held in the form of government securities, the knock on impact on UK government debt, or gilts, may be significant.
And if the global reserve build - fuelled by emerging Asian nations building buffers against a repeat of the 1997-98 financial collapse - has finally peaked, then that easy government funding may be about to ebb just when it is needed most.
Some economists are wary of the UK fallout, particularly once the Bank of England stops buying gilts to stimulate the economy.
At a projected 14 per cent of national output next year, the Organisation for Economic Co-operation and Development expects the UK to have the biggest fiscal gap of the 30-nation bloc.
"If FX reserve growth remains low, or even negative, then FX reserve demand for sterling also will remain low unless sterling's weight in global FX reserves rises rapidly - and that seems unlikely given the UK's poor fiscal position," wrote Citigroup economist Michael Saunders.
International Monetary Fund (IMF) data this week certainly indicates the total reserve build has topped out.
Reserves fell in the first three months of this year for a third quarter in a row, dropping by $171 billion to $6.53trn at the end of March - almost half a trillion off the peak of $7.01trn set in the second quarter of last year.
As the totals are denominated in dollars, the drop is partly explained by a surge in the dollar exchange rate since the middle of last year. That deflates the dollar value of the roughly 35pc of reserves held in non-dollar currencies.
But reserves were also depleted by countries such as South Korea and Russia intervening to defend their currencies and by lower oil prices that capped petrodollar accumulation.
To be sure, the exchange rate, intervention and oil effects may have partly reversed in the second quarter.
Yet the sterling story at least appears to go a bit deeper than simply exchange rate effects.
While the dollar still accounts for about 65pc of the reserves where breakdowns are available, sterling's share has been slipping to 4pc from 4.1pc and well below the 4.7pc level it held at the end of 2007 and early last year.
Saunders at Citi said the weaker sterling exchange rate was partly to blame but, stripping out these effects, there was a £3bn drop in the first quarter after a jump of some 18 billion pounds in final three months of last year.
"The drop in the first quarter is not large, but is the first drop in FX reserves held in sterling since the first quarter of 2003," he wrote, adding that holdings of sterling in global FX reserves had risen by an average of about 8 billion pounds per quarter between 2004 and 2008, when its percentage share rose faster than any other currency.
The significance for British government borrowing can be inferred by the extent to which overseas investors lapped up gilts in the three years to 2008. Citi estimates foreign net purchase of gilts totalled £130bn - or 64pc of total net gilt issuance in that period.
What is more, Bank of England data shows foreign investors made record net sales of gilts between March and May, indicating the second quarter may well have failed to give sterling the rebound that an overall reserves bounce might suggest.
The impact of all this on the gilt market is hard to gauge because the central bank's purchases are supporting prices.
Ten-year UK yields - which move inversely to prices - have risen about 50 basis points to 3.7pc this year, but are well off June peaks of over 4pc and almost two percentage points below the highs of two years ago.
What is more, balance sheet repair and regulatory requirements structurally boosted British banks' gilt holdings.
There is also the possibility the recent push by big reserve holders such as China and Russia to diversify reserves along the lines of a supra-national basket of currencies, such as the IMF's Special Drawing Rights where sterling currently has an 11pc weighting, could underpin sterling holdings.
But the bigger question is whether we have seen the end of reserve accumulation and its attendant funding of western government borrowing - the 'global imbalances' economists partly blame for the credit crisis.
The Bank for International Settlements said initiatives over the past year to pool reserves and boost IMF coffers may lead to a rethink of reserve stockpiling, "which in turn could contribute to reduced global imbalances.
Posted on » Saturday, July 04, 2009
LONDON: If the explosion in global foreign exchange reserves over the past decade is finally over then some western countries that reaped the unexpected windfalls -- such as Britain - may mourn its passing.
The debate about the size and make-up of the almost $6.5 trillion of hard currency reserves stockpiled in the world's central banks is evergreen; the position of dollar as the primary reserve currency a source of endless conjecture.
But the debate also extends to how far the quadrupling of world reserves over the past decade has benefitted the British pound, despite its relatively marginal role in reserve pools.
With reserve holdings typically held in the form of government securities, the knock on impact on UK government debt, or gilts, may be significant.
And if the global reserve build - fuelled by emerging Asian nations building buffers against a repeat of the 1997-98 financial collapse - has finally peaked, then that easy government funding may be about to ebb just when it is needed most.
Some economists are wary of the UK fallout, particularly once the Bank of England stops buying gilts to stimulate the economy.
At a projected 14 per cent of national output next year, the Organisation for Economic Co-operation and Development expects the UK to have the biggest fiscal gap of the 30-nation bloc.
"If FX reserve growth remains low, or even negative, then FX reserve demand for sterling also will remain low unless sterling's weight in global FX reserves rises rapidly - and that seems unlikely given the UK's poor fiscal position," wrote Citigroup economist Michael Saunders.
International Monetary Fund (IMF) data this week certainly indicates the total reserve build has topped out.
Reserves fell in the first three months of this year for a third quarter in a row, dropping by $171 billion to $6.53trn at the end of March - almost half a trillion off the peak of $7.01trn set in the second quarter of last year.
As the totals are denominated in dollars, the drop is partly explained by a surge in the dollar exchange rate since the middle of last year. That deflates the dollar value of the roughly 35pc of reserves held in non-dollar currencies.
But reserves were also depleted by countries such as South Korea and Russia intervening to defend their currencies and by lower oil prices that capped petrodollar accumulation.
To be sure, the exchange rate, intervention and oil effects may have partly reversed in the second quarter.
Yet the sterling story at least appears to go a bit deeper than simply exchange rate effects.
While the dollar still accounts for about 65pc of the reserves where breakdowns are available, sterling's share has been slipping to 4pc from 4.1pc and well below the 4.7pc level it held at the end of 2007 and early last year.
Saunders at Citi said the weaker sterling exchange rate was partly to blame but, stripping out these effects, there was a £3bn drop in the first quarter after a jump of some 18 billion pounds in final three months of last year.
"The drop in the first quarter is not large, but is the first drop in FX reserves held in sterling since the first quarter of 2003," he wrote, adding that holdings of sterling in global FX reserves had risen by an average of about 8 billion pounds per quarter between 2004 and 2008, when its percentage share rose faster than any other currency.
The significance for British government borrowing can be inferred by the extent to which overseas investors lapped up gilts in the three years to 2008. Citi estimates foreign net purchase of gilts totalled £130bn - or 64pc of total net gilt issuance in that period.
What is more, Bank of England data shows foreign investors made record net sales of gilts between March and May, indicating the second quarter may well have failed to give sterling the rebound that an overall reserves bounce might suggest.
The impact of all this on the gilt market is hard to gauge because the central bank's purchases are supporting prices.
Ten-year UK yields - which move inversely to prices - have risen about 50 basis points to 3.7pc this year, but are well off June peaks of over 4pc and almost two percentage points below the highs of two years ago.
What is more, balance sheet repair and regulatory requirements structurally boosted British banks' gilt holdings.
There is also the possibility the recent push by big reserve holders such as China and Russia to diversify reserves along the lines of a supra-national basket of currencies, such as the IMF's Special Drawing Rights where sterling currently has an 11pc weighting, could underpin sterling holdings.
But the bigger question is whether we have seen the end of reserve accumulation and its attendant funding of western government borrowing - the 'global imbalances' economists partly blame for the credit crisis.
The Bank for International Settlements said initiatives over the past year to pool reserves and boost IMF coffers may lead to a rethink of reserve stockpiling, "which in turn could contribute to reduced global imbalances.