Japan may opt for cut in FX reserves over wealth fund
TOKYO (Reuters) - Japan's foreign reserve reforms will probably stay in limbo until financial markets calm down and then bureaucrats may choose to trim the reserves gradually rather than shift them into a sovereign wealth fund.
As Japan's reserves topped $1 trillion (500 billion pounds) this year, the buzz about other nations making high profile investments through sovereign funds made some ruling party lawmakers suggest that Japan should also manage the reserve stockpile more aggressively.
The Ministry of Finance, which controls Japan's currency policy, has resisted the idea of setting up a wealth fund that would invest in potentially higher-yielding, but also riskier assets.
And the proponents of a fund similar to those established by some other Asian nations are now having second thoughts too.
The fear is that the mere creation of such a fund would further unsettle shaky financial markets by triggering speculation that Japan might start shifting out of U.S. assets.
Japan's reserves are held mostly in U.S. dollars.
With the wealth fund a no-go for now, the option of gradually scaling back the reserves looks more appealing, particularly because a special provision in the Japanese budget law obliges the authorities to match the reserves with yen-denominated debt.
"Trimming foreign reserves equals reducing debt, so they should think about steps including selling foreign reserve assets to markets in the future," said Tohru Sasaki, chief foreign exchange strategist at JPMorgan Chase Bank.
QUESTION OF TIMING
Japan's reserves, the world's second largest after China's, ballooned during a yen-selling spree in 2003 and early 2004 in which the authorities offloaded 35 trillion yen to prevent a strong yen from snuffing out an economic recovery.
Even after Tokyo stopped intervening in the currency market four years ago, the government had to keep issuing more bills to match a steady rise in the reserves, which have been growing mainly due to income gains totalling some 4 trillion yen a year.
Lower foreign reserves would mean less bill issues and Hiroshi Watanabe, who served as Japan's vice finance minister for international affairs until last July, told Reuters in June that Tokyo could consider reducing the reserves.
"One way to do it is to sell the same amount of foreign reserves every month no matter what happens, while fully disclosing its plans," said the former currency policy tsar.
He argued there was no need to act immediately, but that the steadily rising short-term bill issuance could risk distorting supply and demand in the debt market in the future.
He said, however, the time was not ripe yet for such a move given the market remained bearish about the dollar.
"The best timing would be when bearishness on the dollar disappears and the market does not feel antipathy towards Japanese sales of its reserves."
Finance ministry sources told Reuters that officials had discussed various ways of trimming the reserves when the yean was broadly weak and remained stable near 120 per dollar. But after the dollar started falling as a result of U.S. mortgage market blowout last August, the opportunity was gone.
Still, Tokyo has taken some small steps, which effectively reduced the size of the reserves, though ministry officials said the measures were taken for other policy purposes.
In May, the Ministry of Finance decided to allow a government-backed lender to exchange its yen funds for dollars from the reserves. The step followed the decision last year to start using dollars from the external reserves for the government's overseas remittance.
The moves involved small amounts relative to the overall size of the reserves and have had limited market impact. But currency traders remain sensitive to any signs of a change in Tokyo's reserve policy. One of the reserve policy's goals is to keep any market distortions to a minimum.
Partly for that reason, the debate has shifted from calls for a wealth fund to manage a part of the foreign reserves to proposals to apply more aggressive management to the nation's public pension funds.
Many policymakers in Japan still have a bitter memory of turmoil in U.S. markets in 1997 prompted by then Japanese Prime Minister Ryutaro Hashimoto, who said Japan had been tempted to sell off U.S. government bonds in the past.
Back then, Japan had some $200 billion in reserves, only one-fifth of what it has now.
Asked last week about the idea of gradually selling foreign reserves in the future, Finance Minister Bunmei Ibuki declined to comment.
"If I talked about selling foreign reserves in the market, I would be Ryutaro Hashimoto all over again. If I answered your question, I would need to resign immediately," Ibuki said.
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