The Hindu Business Line : Rising dollar reserves of Asia — US has to mend its ways; trim deficit

Japan would not be able to stop the appreciation of yen for long. China is going through pain resulting from job losses and any appreciation of the currency would deal a body blow to its export competitiveness.

IF the puritans believe that the monetary and exchange policy are governed by economic fundamentals, they have reasons enough to think again. Suddenly diplomacy seems to have taken centre stage.

How else one can find the rationale behind US Treasury Secretary pitching for trading partner countries to take a part of the burden of the burgeoning US current account deficit by allowing their respective currencies to appreciate against dollar?

In this context, two nations, China and Japan, have been the focus of his pronouncements. What he seems to have earned from these nations is sympathy but little promise of action. Financial markets watched with amusement how the Japanese did not intervene in the foreign exchange market during the time the US Treasury Secretary was in Japan, but drained around JPY 2 trillion immediately after he left the shores. Why is US showing urgency on this score? Would it be possible to make China revalue yuan or Japan to play ball?

It looks unlikely that Japanese would allow dollar to depreciate against yen. Although, it seems that the Bank of Japan is now comfortable with a slightly lower range of 116-118 yen against the dollar, any break of this range on the downside is unlikely. One factor which drives this resolve is the LDP party elections in the second half of September.

The Japanese economy is doing better and there are signs of turnaround in Japan. The GDP data has surprised on the upside and the manufacturing figures also point to growth. However, for a country which has seen a pretty long period of sub-par growth, the urge to `super-insure' growth comes naturally. This would imply that Japan is unlikely to change tack and play ball with US on the foreign exchange any time soon.

On the basis of experience, it can be said that intervention cannot last forever as it starts skewing the money supply and creates more of the flows that it aims to tackle. It can be inferred that Japan would not be able to stop the appreciation of yen for a long time and the risk of dollar moving closer to 112 against the yen would increase over time.

On the other hand, China has held a peg on the currency and its currency is undervalued, although relative to the Asian currencies China's does not seem to be significantly undervalued.

China is going through a pain resulting from job losses due to its joining the World Trade Organisation. In such times, any appreciation of the currency would deal a body blow to the export competitiveness of its businesses. China had not moved the currency range in early 1990s when it would have helped its export houses; it is unlikely that they will do so now.

The US does not have the power to push China or Japan to comply. Oddly this stems from the large surpluses that these economies and some of the other economies in the Asian region are running.

One look at the US overseas holding of marketable and non-marketable treasury securities data - - one understands the dilemma.

Around 35 per cent of US Treasuries have foreign ownership. Out of the foreign holdings, around 35 per cent is owned by Japan and around 10 per cent by China!

Most of the central banks in the Asian region are grappling with a huge influx of dollars. An IMF report released last week cautioned about these reserves.

The reserves built for fighting any attack on the currencies have risen past a trillion dollars! These banks now have a problem of plenty and do not know how to use these funds.

Most of the dollars are finding their way into US Treasuries. The US would be pleased that this is helping them fund their deficit. But it would also give them shudders to think of the implication if these central banks were to decide to sell these holdings or diversify. Such a move can have serious implications on the long end of the dollar yield curve.

In light of such a clout it is unlikely that US can put undue pressure on Japan and China to act according to its will. It is certain that the dollar weakness has to continue in United States' interest.

However, European Central Bank is unlikely to accept euro appreciation beyond 120 against the dollar.

The US search for trading partners who can take part of the load from its current account deficit would continue.

Could it be that all these pronouncements are being made keeping in mind the Presidential elections in 2004?

This might be true, but in any case US would have to tighten its belt in the years ahead and may not be able to continue to run reckless Budget deficits.

(The author is Senior Manager, Corporate Treasury Sales - Western India for HSBC. The views expressed herein are his own and not necessarily those of his employer.)

Article E-Mail :: Comment :: Syndication

Stories in this Section
Rising dollar reserves of Asia — US has to mend its ways; trim deficit

ICICI Bank's new ATM in Coimbatore

State Bank of Saurashtra ties up with Maruti in Gujarat

Bond traders cautious ahead of RIB payout

Corporation Bank to collect Central excise, service tax