Japan may opt for cut in FX reserves over wealth fund

By Yoko Nishikawa

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.