SYDNEY MORNING HERALD Date: 31/12/98

E-DAY EVE

Support from Asia will be key barometer of currency's future

By MARK MAGNIER in Tokyo

Perhaps no other part of the world will have as great a voice as Asia in establishing Europe's new euro as an international reserve currency.

Many Asian investors and companies have indicated their support in advance of the euro's introduction tomorrow. Japan's biggest insurer, Nippon Life, promises to shift as much as half its $US34 billion ($55.7 billion) in overseas assets into euros, much of that from dollars.

However, the bigger test will be the support the euro receives from Asia's central banks. Japan, China, Taiwan and Hong Kong alone boast nearly $US1 trillion in foreign reserves.

Although the United States and Europe have a strong political interest in supporting their respective currencies as global reserves, the powerful Asian central banks have less at stake in the euro's future role as a global currency. Thus their decision to move into - or shy away from - euros provides a more objective test of the new currency's progress.

"Asian central banks are going to be quite a barometer," said Mr Michael Pitcher, the Asia-Pacific vice-chairman at Barclays Capital.

"In terms of foreign reserves, the three richest states in the world are in Asia: Japan, China and Hong Kong."

Asia's appetite for euros will be driven by its desire to spread its risk and by how much confidence it has in Europe's economic and political outlook, the continent's ability to check inflation and social spending, and its growth prospects.

A reserve currency is one that is easily convertible, widely used in global trade and commonly held by central banks. Since World War II, the US dollar has been the world's leading reserve currency.

That is not to say that Asian nations do not have their own interest in this financial power play. Reversing a longstanding policy, Japanese officials recently began promoting the yen in this role, apparently hoping to ride the euro's coat tails.

However, analysts are sceptical that Japan can make many inroads against the dollar or the euro in the near future - even among Japanese companies - given the yen's volatility, Japan's dismal economic outlook and the tendency of its bureaucrats to meddle.

Meanwhile, other Asian nations, having recently dropped their currencies' direct peg to the dollar, may want to reduce their own dependence on the greenback.

The rise of a new global currency is rare, the recent jockeying to weaken a global currency's grip not having been seen since the first half of this century, when the British pound gave way grudgingly to the US dollar.

Why all the interest in having a nation's printing presses crank out a world currency? For one thing, it becomes much easier to finance government debt, a factor that helped the US with its huge budget deficits in the 1980s, because underlying demand for the currency remains strong.

It can also benefit the nation's exporters, since their sales and most of their costs are in the global currency, while foreign partners may have costs in one currency and sales in another, making them vulnerable to sudden currency shifts.

However, the biggest incentive ultimately may be national pride - the status it gives a country on the global financial stage.

"It's what you might call economic machismo," said the chief economist with Lehman Bros Japan, Mr Russell Jones.

Most Asian central banks have been cautious about committing to shift out of the estimated 75 per cent of foreign reserves they hold in dollars. China has said it will reduce its dollar holdings in favour of euros, but countries such as Japan and Taiwan, with the largest US dollar holdings, are reluctant to make a sudden move that could erode the value of their national nest egg.

An analyst with Japan's Kankaku Research Institute, Mr Hiroshi Sakurai, said: "Japan holds 40 per cent of the short-term US government bonds, so it can't afford to touch this. China, on the other hand, has only a small percentage."

However, over time, given the sheer amount of foreign reserves held in east Asia - about $US800 billion to $US1 trillion, analysts estimate - even a relatively conservative 5 per cent to 15 per cent shift out of dollars into euros could have a sharp impact on global currency markets by weakening the dollar. Over time, as the euro, dollar and even the yen jockey for position, it could also increase volatility, making it more difficult for companies to plan.

Asian financiers will pay attention to Europe's discipline and the ability of member countries to keep social spending under control.

A finance official at Fukoku Mutual Life Insurance Co said: "European politics are controlled by leftists, and they will most likely expand their finances. In the end, the euro may not work out."

- Los Angeles Times