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EXCLUSIVE-UPDATE 2-Asia cbanks to stick with Treasuries -sources

Published 06/03/2009, 06:13 AM
Updated 06/03/2009, 06:24 AM
SOGN
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* US Treasury bond is partnership between China and US-source

* Debt ratings only one factor in reserve decisions-sources

* No alternatives to dollar-India, Japan, S.Korea sources (Adds market reaction, quotes)

By Hideyuki Sano and Yoo Choonsik

TOKYO/SEOUL, June 3 (Reuters) - Asia's richest central banks would shrug off losses from a U.S. sovereign credit rating downgrade and continue to buy Treasuries to keep markets stable, officials and others with direct knowledge of policymaking say.

The sources, in separate interviews with Reuters, said a ratings cut would not cause China, Japan, India and South Korea to change their reserve policies, at least in part because there are no alternatives to the liquidity afforded by the dollar.

A U.S. rating cut would weaken the dollar and could wreak havoc on investments around the world benchmarked against Treasuries.

The remarks on four countries that control about half of the world's foreign exchange reserves caused the euro and the pound to extend losses on the day against the dollar, which has been weakening steadily for the last month.

"They (central banks) are not competing against mutual funds or hedge funds. If they make a loss it's okay, as long as they are sticking to the investment policy imposed from the very top, because they are not concerned with short-term gains or losses," said a person familiar with the thinking of Chinese reserve managers, who spoke on condition of anonymity because of the sensitivity of the issue.

"The U.S. Treasury bond is a partnership the Chinese government holds," the person added, stressing that selling down dollar-denominated assets could hurt the political relationship between China and the United States.

China is the single largest U.S. creditor, holding $768 billion of Treasuries in March, up 56 percent in the last year.

Besides China, other Asian central banks have also been replenishing their foreign reserves. In April, reserves in Asia ex-China rose $15.2 billion to $2.46 trillion.

While some private economists said a U.S. downgrade is highly unlikely, none of the Asian officials who spoke to Reuters dismissed the possibility, though they said it would have a limited impact on their reserve management policy.

"Even if there is a risk of a U.S. downgrade it is not feasible for central banks to move investments quickly as it would have implications for the global markets," a senior Indian central bank official, who is not authorised to speak to journalists, told Reuters.

"Moreover, U.S. markets are still the most liquid and the deepest in the world."

India has $260.6 billion in foreign reserves, the fifth-largest in the world. It has been rapidly adding to its Treasury holdings, owning $38.2 billion in March compared with $11.8 billion a year earlier, U.S. government data show.

The euro tumbled to $1.4221 from around $1.4280, where it was shortly before the news. The pound fell to $1.6545 from around $1.6620 after Reuters published the comments.

"These comments reflect the concerns of foreign official investors in the dollar's recent move lower," said Mitul Kotecha, head of global foreign exchange research for Calyon in Hong Kong.

"Although central banks want to eventually diversify from dollars, they don't want the dollar to collapse and there is a real risk of the dollar move getting out of control," he said.

Fears of a U.S. downgrade grew after Moody's cut Japan's top credit rating in May and Standard & Poor's lowered its outlook on Britain's rating to negative, giving it a one-in-three chance of rating downgrade.

Worried investors pushed up the 10-year Treasury yield some 40 basis points in the last two weeks and knocked the dollar down to 2009 lows against the euro.

"A rating is one of many yardsticks we look at when we manage reserves. It's nothing more, nothing less," said a senior official at Japan's finance ministry. "Safety and liquidity are what we care about the most when we manage reserves."

Japan's foreign reserves were $1.01 trillion as of April, the second-largest stockpile in the world. Japan owned $687 billion in Treasuries at end-March, up 15 percent from a year ago.

STICKING WITH POLICY AND DOLLARS, FOR NOW

Worries about the rapidly growing U.S. fiscal deficit and debasement of the dollar could keep push up Treasury yields, making it perhaps more attractive to put off purchases of U.S. debt and reach for higher yields later. But reserve managers are more concerned with stability than returns.

"It is highly rational that you would have comments like these from the main reserveholders in Asia -- they are the people with a natural interest in providing supportive comments for the dollar," said Simon Derrick, head of currency research at Bank of New York Mellon in London. "They are sending a strong signal to the market that they are not going to dump dollars."

In recent weeks, Chinese leaders and economists have expressed concern about the safety of their U.S. dollar debt.

But U.S. Treasury Secretary Timothy Geithner, who is in Beijing for meetings with Chinese leaders, said on Tuesday China expects the dollar to remain the prime reserve currency and was confident in the U.S. response to the crisis.

Sources who spoke to Reuters underscored the importance of holding dollars over other assets because of its stability.

"Even if the rating is cut, what will the rich countries buy?" said a senior official at a South Korean financial authority.

"Do you think they will hold the weakening dollars in cash? Will they buy gold or Chinese bonds? Never. They can't enter into the volatile commodities markets. You may say it is regrettable, but there are no alternatives."

Korea's foreign reserves, the sixth-largest in the world, had the biggest monthly rise ever in May to $226.77 billion.

While officials talked down the impact of a U.S. downgrade on reserve policy, some market watchers in the private sector were already anticipating the chain reaction such a move would cause.

"Nowadays, the rating agencies are more careful than before, so they may react ahead of time," said Daniel Truchi, head of Societe Generale's private bank in Singapore. "If we start downgrading government bonds, then what happens to the corporate bonds and equities? We are in a very dangerous zone." (Additional reporting by Saikat Chatterjee in MUMBAI, Kevin Lim in SINGAPORE, Swaha Pattanaik in LONDON and Kevin Plumberg in HONG KONG, Writing by Kevin Plumberg; Editing by Jan Dahinten)

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