China to Add Emerging-Market Currencies to Reserves

President Of The Central Bank Of Peru Julio Velarde
Peruvian central bank President Julio Velarde said in an interview in August he is “surprised” to see several monetary authorities buying government bonds denominated in the sol. Photographer: Jonathan Fickies/Bloomberg

China is moving to add more emerging-market currencies to its foreign-exchange reserves, a strategy central banks around the world are following to diversify their $8.7 trillion in holdings.

“We can diversify more the foreign reserves, to consider not only smaller countries, but some emerging-market economies,” central bank Governor Zhou Xiaochuan said at an event during a meeting of the International Monetary Fund in Washington yesterday. With increased assets, “you can shift some to riskier, but higher-return investment instruments,” said Zhou.

China almost tripled its holdings of South Korean government bonds to 5.15 trillion won ($4.6 billion) in the first nine months of this year, according to South Korea’s Financial Supervisory Service. Peruvian central bank President Julio Velarde said in an interview in August he is “surprised” to see several monetary authorities buying government bonds denominated in the sol.

The desire among policy makers to diversify into developing nations’ currencies comes as the U.S. economy is hobbled by job losses and Europe faces widening budget deficits. The IMF forecast this month that developing nations will expand 6.4 percent next year, outstripping growth of 2.2 percent among advanced economies.

Greater Volatility

“The Chinese authorities are some of the smartest in the world,” Kenneth Akintewe, a Singapore-based investment manager at Aberdeen Asset Management Plc that oversees $261 billion globally, said in an interview on Oct. 11. “If you look at the fundamentals of a lot of these emerging markets, they are considerably better than developed markets. Who wants to be holding U.S. dollars at this stage?”

Emerging-market currencies have rallied in the past month, with the Hungarian forint gaining 13.6 percent, India’s rupee rising 4.7 percent, Brazil’s real 3.5 percent and China’s yuan 1.5 percent.

The move may add more “volatility” to emerging-market currencies as developing nations from Brazil to South Korea attempt to slow capital inflows and stem their currency appreciation, according to Arminio Fraga, Brazil’s former central bank president.

“It seems to be a natural evolution,” Fraga, now chairman of BM&F Bovespa SA in Sao Paulo, which owns Brazil’s securities exchange, said in an interview. “There has been an increase in the importance and quality of investment opportunities in emerging countries and I believe the central banks see that too.”

International Reserves

China’s international reserves, the world’s largest, increased 15 percent over the past year to almost $2.5 trillion as of June as the central bank bought the dollar to keep the yuan from appreciating. China is the biggest holder of U.S. Treasuries, with $846.7 billion in August. It started a sovereign wealth fund, China Investment Corp., in September 2007 to help diversify the reserves to generate better returns.

Mexico is seeing “very active” interest from Chinese investors in the country’s local-currency government bonds, Octavio Lara, deputy general director of debt issuance at Mexico’s Ministry of Finance, said Sept. 15.

In the 1990s, developing nations were beset by currency crises. Mexico devalued its currency in 1994, sending the peso down 55 percent in a year. During the Asian financial crisis in 1997 and 1998, South Koreans lined up to donate jewelry to help the central bank build dollar reserves and stem a flight of capital.

Leading Gainers

Now, emerging-market currencies are leading gainers after developing nations cut foreign debt to 26 percent of gross domestic product last year from 41 percent in 1999, IMF data show. The Brazilian real appreciated 61 percent since January 2005, Colombia’s peso climbed 31 percent and Thailand’s baht rose 30 percent. Those gains compare with an advance of 3.5 percent in the euro.

Global foreign reserves have more doubled from $4 trillion at the end of 2005, according to data compiled by Bloomberg and the IMF. Developing nations held $5.5 trillion as of June.

Diversification is in line with the “multi-polar” development of the global economy, said China’s Zhou. As foreign reserves grow, “you don’t need to keep a large” share in “very liquid assets,” he said.

Currencies other than the dollar, the euro, the pound, the yen and the Swiss franc jumped to 3.8 percent of global foreign reserves as of June, the most since the IMF started to compile such data in 1999.

Dollar’s Share

The dollar’s share has declined to 62 percent in June, from 73 percent in 2001, according to data compiled by the IMF. The share of euro, the world’s second-largest reserve currency, fell to 26.5 percent in June this year, from a record 28 percent in September 2009, as Greece received a $110 billion euro ($153 billion) bailout to finance its budget deficit that is equivalent to almost 14 percent the size of its economy.

“Reserve currencies have to be a good store of value, good medium of exchange, in great demand, in great supply, etc.,” Philippine central bank Deputy Governor Diwa Guinigundo said in an interview. “The Chinese yuan and Russia’s ruble are strong currencies, and it will just be a matter of time before they qualify as reserve currencies.”

China is also moving to promote the yuan’s role in international trade and financial markets. The central bank said last month it will allow more regions and companies to settle cross-border trade in the nation’s currency and boost offshore usage of the yuan. Bank of Thailand Assistant Governor Suchada Kirakul said the bank plans to buy yuan-denominated bond.

“What we will see is probably a future with more and more currencies within the reserves,” said Peruvian central bank President Velarde. “Diversification makes all the sense.”

There will be as many as 40 currencies in central banks’ foreign reserves in the next two decades, according to Velarde.

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