Central banks diversifying by selling US$, survey shows

By Aaron Pan and Stanley White LONDON/TOKYO, Bloomberg

Central banks are increasingly diversifying their reserves, including cutting holdings of dollars, according to a survey sponsored by Royal Bank of Scotland Group PLC, the U.K.’s second-largest bank.

Italy, Russia, Sweden and Switzerland have made “major adjustments” in foreign-exchange holdings favoring the euro and the British pound, according to the poll conducted by Central Banking Publications Ltd. between September and December. China also plans to manage its reserves more actively, the report said.

“Central banks are open to saying they’ve been diversifying to improve returns and reduce exposure to any single currency,” said Sean Callow, senior currency strategist at Westpac Banking Corp. in Singapore. “There’s no doubt that when they say ‘diversification’ they mean selling dollars.”

Diversification could make it more difficult for the U.S. to fund its current-account deficit, the broadest measure of trade in goods and services, and cause yields on Treasury bonds to rise. The dollar accounted for 65.6 percent of the world’s currency reserves in the third quarter, according to the International Monetary Fund.

The U.S. current-account deficit widened to a record US$255.6 billion in the third quarter of 2006, according to the Commerce Department. When a country runs a deficit in the current account, it relies on overseas investment to offset a shortfall in savings. Net purchases of U.S. stocks, notes and bonds by investors abroad fell to US$15.6 billion in December, the lowest in almost five years, according to the Treasury Department.

“Central banks are diversifying further in terms of instruments, currencies and markets,” wrote Nick Carver, an assistant editor at the London-based Central Banking Publications in the report called RBS Reserve Management Trends 2007.

The U.S. currency traded at US$1.3182 per euro at 6:30 a.m. in London from US$1.3166 on Feb. 23. The pound stood at US$1.9625 from US$1.9633. The dollar bought 120.97 yen from 121.08.

Nineteen of 47 central banks surveyed had cut their share of dollars, while 10 said they had increased holdings. Twenty-one respondents said they had increased their reserves of euros, compared with seven who said they had reduced their holdings of the single currency. The 47 respondents in the survey hold a total of US$1.5 trillion in reserve assets.

Nine central banks also increased their share of the pound, citing the yield on sterling-denominated assets as the most popular reason. Central banks bought US$36.2 billion of reserves in pounds in the four quarters ended September 2006, according to the IMF.

The Bank of England last month raised interest rates to a five-year high of 5.25 percent, with the consequent higher yield in U.K. assets attracting investors. That compares with a benchmark rate of 3.5 percent in Europe and 0.5 percent in Japan.

Thirty-six percent of the 47 central banks that responded said they have made “major changes” to their investment strategy in the last two years, the poll said. Eighty-nine percent said central banks haven’t approached the limits of “practical” diversification, according to the poll.

Central banks are still investing in riskier assets as they chase greater returns on yields. Sixty-nine percent said they were looking for more yield, having been forced to widen their asset range by a low-yielding environment.

More than half of the respondents said there is scope for central banks to diversify beyond traditional assets into equities, and around a third said banks should invest in commodities.