Japan says it won't diversify reserves out of dollar


By Yoko Nishikawa
Friday, March 23, 2007


TOKYO -- Japan has no plans to divert its foreign currency reserves -- the world's second largest -- out of dollars and will not sell foreign assets to help redeem its government bonds, Finance Minister Koji Omi said on Friday.

It now also expects a higher funding cost for its external reserves due to recent rate hikes by the Bank of Japan after years of enjoying virtually zero costs while earning much higher returns from its mainly dollar-denominated reserve assets.

The currency breakdown of Japan's external reserves is a state secret, but historical data on the country's currency intervention, which has mostly taken the form of dollar buying, suggests most of Tokyo's hefty reserves are in U.S. dollars.

"We do not comment on the composition of currencies in foreign reserves as it may have an unexpected impact on markets, but we have no plan to substantially change the composition," Omi told a parliamentary committee.

Acknowledging that most of Japan's official reserves, which reached a record $905.048 billion in February, are in dollars, Omi also stressed that Japan's reserve portfolio management focuses on ensuring the stability and liquidity of assets while pursuing their profitability under those constraints.

Over the past few years, Japan has diversified the types of dollar-denominated assets in its reserves, shifting to more active management from its traditional buy-and-hold policy.

But it has stressed that it would not shift its reserves into other currencies such as euros, as it knows that even a suggestion of such moves could trigger a sharp dollar selloff, which would not be in Japan's interest.

Japan's reserves ballooned after yen-selling intervention worth a record 20 trillion yen ($169.5 billion) in 2003 and a further 15 trillion yen in the first three months of 2004, when the government fought to prevent a rapid yen rise from aggravating deflation and derailing an export-driven recovery.

Tokyo has not intervened in the market since then, as the world's second-largest economy has been enjoying modest but healthy economic growth and shown signs of breaking free from years of deflation.

Hiroshi Watanabe, vice finance minister for international affairs, told reporters that Japan, unlike China, has no plan at the moment to create a new investment body to more aggressively manage its foreign reserves.

Some lawmakers at the parliament committee suggested that a special account that holds Japan's foreign currency assets acquired through intervention, called the Foreign Exchange Fund Special Account, could be used to help finance Japan's public debt by redeeming government bonds.

But Omi noted intervention has been financed by borrowing yen by selling short-term government paper.

Even if Japan sells dollars for yen in the market in the future, that will be used for paying back three-month finance bills, which the ministry uses to fund its foreign exchange special account.

"Thus, we don't have any plans to sell foreign currencies to redeem government bonds," Omi said.

The forex account paid about 7.56 billion yen in interest in the fiscal year that ended in March 2006, while earning some 3 trillion yen in interest rate income and other investment revenues.

Three-month finance bills yield about 0.58 percent, while three-month U.S. Treasury bills yield 5.05 percent.

Part of those gains are set aside as a cushion for potential losses that could arise from a higher yen and any reversal in U.S.-Japan interest rate differentials, although Watanabe said such a reversal was unlikely in the near future.

A new bill, which was debated in the committee, says the forex account can earmark up to 30 percent of Japan's foreign assets for such purposes, on the view that earmarking such an amount means the health of the special account would not be hurt by its unrealised losses.

Tokyo, meanwhile, expects higher funding costs after the BOJ scrapped its zero interest rate policy last year and has since raised the key overnight call rate target to 0.5 percent.

It now estimates that the special account will need to pay 460.6 billion yen in interest in the current fiscal year ending on March 31 and 1.16 trillion yen in fiscal 2007/08. ($1=117.98 yen)

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