Pound reserves hint at government debt vulnerability

By Mike Dolan - Analysis

LONDON (Reuters) - If the explosion in global foreign exchange reserves over the past decade is finally over then some western countries that reaped the unexpected windfalls -- such as Britain -- may mourn its passing.

The debate about the size and make-up of the almost $6.5 trillion (3.97 billion pounds) of hard currency reserves stockpiled in the world's central banks is evergreen; the position of dollar as the primary reserve currency a source of endless conjecture.

But the debate also extends to how far the quadrupling of world reserves over the past decade has benefited the British pound, despite its relatively marginal role in reserve pools.

With reserve holdings typically held in the form of government securities, the knock on impact on UK government debt, or gilts, may be significant.

And if the global reserve build -- fuelled by emerging Asian nations building buffers against a repeat of the 1997/98 financial collapse -- has finally peaked, then that easy government funding may be about to ebb just when it is needed most.

Some economists are wary of the UK fallout, particularly once the Bank of England stops buying gilts to stimulate the economy.

At a projected 14 percent of national output in 2010, the Organisation for Economic Cooperation and Development expects the UK to have the biggest fiscal gap of the 30-nation bloc.

"If FX reserve growth remains low, or even negative, then FX reserve demand for sterling also will remain low unless sterling's weight in global FX reserves rises rapidly -- and that seems unlikely given the UK's poor fiscal position," wrote Citigroup economist Michael Saunders.