March 24 (Bloomberg) -- Asian governments were reaching for the cookie jar when Standard & Poor's slapped them on the wrist.

Taiwan, Thailand, India and South Korea want to use a part of their official foreign reserves for local public works.

While Asian central banks' $2.4 trillion war chest of U.S. Treasuries and other securities is an alluring source of financing roads, bridges, subways and power stations, such plans may have ``possible negative implications'' for sovereign ratings, S&P said.

The rating company's reservations, outlined in its report this week entitled, ``Dipping into Foreign Exchange Reserves -- Something for Nothing or Dangerous Folly?'', are valid. S&P analysts, Agost Benard and Ping Chew, are correct in asserting that using reserves for domestic purposes is akin to deficit spending.

Even so, the various proposals to use reserves locally aren't merely a result of imprudent politics, as S&P seems to suggest.

``The popularity of using what is often perceived by the public and politicians to be `idle cash' to fund infrastructure projects -- possibly adding to the country's stock of wealth -- is understandable,'' Bernard and Chew wrote. ``It's also a politically tempting one, with sure voter appeal through the implied preclusion of tax rises or spending cuts, as well as job creation,'' S&P said.

That isn't the whole story. The desire to use reserves for infrastructure also has an economic rationale, arising out of legitimate concerns about the fate of the U.S. dollar, the currency in which a large part of the reserves are invested.

No Free Lunch

One needn't be too pessimistic about Asian nations' efforts to move a tiny part of their reserves from liquid, low-yielding securities like Treasuries to illiquid, high-yielding assets such as roads and bridges at a time when there is no need for them to be ready to sell dollops of dollars at a short notice. Depreciation pressures aren't there for most Asian currencies.

When Montek Singh Ahluwalia, deputy chairman of India's economic planning agency, says he favors using $5 billion a year from India's $140 billion reserves for public works, he's under no illusion that he could get something for nothing.

Ahluwalia, a former head of International Monetary Fund's evaluation office in Washington, is aware that his plan of borrowing from the reserves would push up the national budget deficit, which is already high at 10 percent.

The move may also stoke inflation because the central bank will create new money, though prices may only rise for a while. ``Once productive capacity is augmented, pressure on prices will recede,'' says Chetan Ahya, a Morgan Stanley economist in Mumbai.

Reserves Swell

Contrast this somewhat risky move with doing nothing.

As reserves keep swelling, the cost of holding them will rise, as will the valuation loss on the central bank's balance sheet from depreciation in the dollar. It might be better for governments to tolerate larger fiscal deficits and spend on a few highways than to have to pay for the central banks' loss.

``If our reserves become as large as China and Japan, (lending to local companies) is something to consider in the long term,'' Rhee Gwang Ju, head of Korean central bank's international department said this month. ``This will need the support of a national consensus.'' Korea's $202 billion reserves are the world's fourth-largest after Japan, China and Taiwan.

China, meanwhile, may use reserves to buy crude oil, the China Business Post reported on March 13.

The most populous nation has used $45 billion from its reserves to re-capitalize state-owned banks. The Chinese move didn't involve creation of local money, though it did lead to a diminished reserve cushion that was soon more than replenished by a rush of speculative dollar inflows.

Expensive Cushion

Asia's central banks mop up dollars and put them in reserves so that their currencies remain more or less fixed against the U.S. dollar, protecting exporters' profits. The region also needs a hard- currency cushion to ensure importers aren't deprived of dollars, overseas creditors get paid and speculators are dissuaded.

Mercantilism and prudence have both reached their limits.

It's generally agreed that China, Taiwan, Korea, India, and to a lesser degree Thailand, are ``sitting on reserves that provide a more-than-comfortable cushion when faced with temporary difficulties,'' S&P said

More-than-comfortable is uncomfortable.

China, whose currency is pegged at 8.3 to the dollar, has to buy dollar inflows and sell bonds and bills to check money supply. The Chinese central bank paid 21.5 billion yuan ($2.6 billion) in interest in 2004 on the debt it sold to keep the peg, says Stephen Green, a Standard Chartered Bank economist in Shanghai.

End Game

Asian Central banks will ultimately have to slow the pace of reserve accumulation and allow their currencies to appreciate.

Pending that, ``public criticism of large scale foreign- exchange intervention is growing,'' Dominique Dwor-Frecaut, Asian emerging market strategist at Barclays Capital in Singapore, wrote in a March 11 research note, ``which can only increase the focus of foreign reserves investment policies on rates of return.''

If that means investing a small part of reserves at home, there is no great harm done.

To contact the writer of this column: Andy Mukherjee in Singapore amukherjee@bloomberg.net

Last Updated: March 23, 2005 16:08 EST