Central banks’ influence set to wane, despite rise in reserves

January 7, 2014 8:35 pm

Central banks’ influence set to wane, despite rise in reserves

By Delphine Strauss in London

Central banks rebuilt foreign currency reserves in the third quarter of 2013 but their influence in currency markets may decline as the US Federal Reserve scales back its exceptional stimulus.China will not benefit from any further accumulation in the country’s vast foreign exchange reserves, Yi Gang, the central bank’s deputy governor, has said, pledging to draft detailed rules for currency reforms this year.

His comments, published in China Forex magazine on Tuesday, follow a year when the twists and turns of Fed policy forced many central banks to intervene in markets to support their currency or to limit its appreciation.

Brazil and Turkey are among emerging markets whose authorities had worried about currency appreciation as US quantitative easing drove hot money inflows but stepped in to stem their currencies’ slide when the Fed’s plans to withdraw stimulus sparked a sell-off in emerging markets.

International Monetary Fund data published at the end of December show that growth in central bank reserves resumed in the third quarter of the year as emerging markets stabilised, with total holdings rising from $11.1tn to $11.4tn – although a weak dollar during this period exaggerates the pace of growth.

China has released figures showing its foreign exchange reserves hit a high of $3.66tn in the same period. This partly reflects a continued trade surplus but it is also because the Fed’s decision to delay “tapering” and the resulting weakness in the dollar will have forced the central bank to step up its interventions to hold down the value of the renminbi.

The Swiss National Bank’s disclosure this week of a SFr9bn ($9.9bn) loss on its gold holding highlights the risks of accumulating large reserves.

Mr Yi said the marginal cost of accumulating reserves now exceeded the marginal benefits, in comments that are consistent with China’s intention gradually to remove capital controls and liberalise the renminbi. But he may also be hoping that China’s need to stockpile reserves will lessen as the Fed begins cutting back its asset purchase programme. Many analysts think this, combined with a US recovery, will trigger a multiyear rally in the dollar.

China has driven the last decade’s surge in foreign exchange holdings but other central banks have also increased their reserves rapidly as they bought dollars to weaken their currency. South Korea, which has struggled to contain a rise in the won, said its reserves increased $1.79bn to a record $345bn in November, though it said the rise was largely because of assets appreciating.

Slower growth, or even declines, in central banks’ reserves will have wider implications for currencies that have been supported by a trend for reserve managers to diversify as they increased their holdings.

The latest IMF data suggest that reserve managers are still increasing their holdings of Australian and Canadian dollars, the main beneficiaries of this diversification in recent years, but at a much slower pace.

Once the figures are adjusted for currency movements over the period, there is no sign of central banks turning away from the dollar, even though it was under pressure in September as debt talks in Washington ground towards a standstill.

Instead, notes Kiran Kowshik, strategist at BNP Paribas, reserve managers cut their holdings of euros, with aversion to the single currency especially marked among emerging market reserve managers.