Dollar holds firm grip on reserve currency status

Figures from the Bank for International Settlements this week show the dollar accounted for 69 percent of global foreign exchange reserves at the end of last year, slightly below peaks seen in 2001.

But factor in the dollar's 30 percent slide against the euro and 18 percent fall against the yen over that period and a different picture emerges. Not only are central banks amassing reserves in record amounts but they are bagging more dollars than before.

"When you remove valuation effects, there has been a big increase in the dollar's proportion of central bank reserves," said Marvin Barth, senior currency economist at Citigroup.

Barth notes there has been a positive correlation between the dollar's slide and the rise of U.S. currency assets in central bank coffers.

In 2000, when the dollar was pushing to 15-year highs against a basket of currencies, less than 27 percent of new reserve accumulation was in dollars. Last year, when the dollar was tumbling across the board, nearly 88 percent of new central bank holdings were in dollars.

ASIAN ROAR

A rush to buy dollars just as the currency is tumbling may seem an odd investment decision. But central banks are not typical investors and making money plays second fiddle to broader economic goals.

Central banks in export-reliant Asia have been particularly big buyers of dollars as authorities have sought to protect export competitiveness.

Japan sold a record 20 trillion yen in 2003 to prevent appreciation against the dollar, while China has had to devour dollars to maintain its currency peg.

"The accumulation of central bank reserves reflects the sheer scale of dollar-buying intervention from Asia, particularly Japan," said Derek Halpenny, currency economist at Bank of Tokyo Mitsubishi.

Official data show Asian central banks held $2.13 trillion of combined foreign exchange reserves at the end of March, up from $1.91 trillion at the end of 2003 and $1.44 trillion at the end of 2002.

While more recent than those calculated by the BIS, these figures -- released by the central banks -- do not show a breakdown by currency.

Apart from the BIS, the only other organisation to release such data is the IMF. Based on current rather than constant exchange rates, IMF data shows the dollar's share of foreign exchange reserves slipped to 64.5 at the end of 2002 from 67.5 the previous year, while the euro's share edged up to 18.7 percent from 16.4.

The IMF has yet to publish data for 2003.

MAKING WAVES

With more than $3 trillion in reserves, central banks are big hitters on foreign exchange markets and their investment decisions can send shockwaves through the markets.

While the BIS figures show little evidence of this happening, Asia central banks have repeatedly talked up plans to raise the euro component of their reserves.

China -- owner of the world's second largest foreign exchange reserves after Japan -- has said it plans to include more European and Asian bonds in its reserves, while a Philippines central bank official told Reuters at the weekend he saw scope for further increases in the proportion of euro holdings.

Russia said earlier this year it planned to move from a dollar-based currency target to a basket comprising both dollars and euros, a move analysts say could have far-reaching currency implications.

Russia has total reserves of around $88 billion, only a quarter of which are in euros, so a projected move to a 50/50 weighting could trigger additional euro buying to the tune of $22 billion, notes Michael Metcalfe, senior strategist at State Street.

What would interest the market more, reckons Metcalfe, would be if Russia were to increase these reserves further by charging for its oil in euros.

Europe is Russia's largest export market for oil and gas and such a move could set a precedent for other oil exporters, many of whom have already mooted the idea of pricing oil in euros rather than dollars.

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