Russia may add the Australian and Canadian dollars to its international reserves for the first time after fluctuations in the U.S. currency and euro, Alexei Ulyukayev, the first deputy chairman of the nation’s central bank, said in an interview in Moscow on June 15. The International Monetary Fund may add the Aussie and loonie to a basket of currencies it uses in transactions, strategists at UBS AG, the world’s second-largest foreign-exchange trader, predict.

Reserve managers are joining private-sector investors including Pacific Investment Management Co., which runs the world’s biggest bond fund, in boosting allocations to nations with improving economies and the ability to reduce budget deficits after the European Union was forced to commit almost $1 trillion to prevent a sovereign default by Greece.

The failure to coordinate fiscal policy among the 16 nations making up the euro increases the risk a country may leave the currency union, according to Andrew Balls, head of European portfolio management at Pimco, and Jim Rogers, chairman of Rogers Holdings.

‘Possible Exit’

“The range of possible outcomes includes the preservation of the current euro-zone, albeit as a weaker entity unless urgent progress is made on a deeper fiscal union, or one or more euro-zone members restructuring their debt and also the possible exit of a current member country,” Balls wrote in a research report dated June 14.

Japan’s debt is approaching 205 percent of gross domestic product, the highest among the 31 members of the Organization for Economic Cooperation and Development, the OECD said on May 26. The U.S. budget deficit is forecast to reach a record $1.6 trillion this fiscal year, according to the White House, and the Congressional Budget Office said in January that total debt will reach 60 percent of GDP by the end of the year, the highest level since 1952.

‘All Impaired’

“If you just laid the numbers out without identifying them, it’s hard to make the case that Europe, the United States or Japan should be part of reserve portfolios,” said Steven Englander, head of Group of 10 currency strategy at Citigroup Inc. in New York. “They are all impaired over the longer term perspective.”

Greece’s borrowing costs have doubled to 9.4 percent for 10-year notes since October, while yields on Portuguese debt rose as high as 6.3 percent last month, the most since the euro began trading in 1999. On June 18, the interest rate investors demand to hold Spanish debt rose as high as 5 percent, the most since July 2008. Last month the EU announced a 750 billion-euro ($921 billion) rescue mechanism to stabilize the market.

For reserve managers, the euro-area sovereign debt market has essentially shrunk to 20 percent of its previous size, with primarily German debt meeting central bank standards, said Alan Ruskin, head of currency strategy at Royal Bank of Scotland Group Plc in Stamford Connecticut.

Euro Assets Shrinking

“The shrinkage in high-quality euro assets that reserve managers can buy does significant damage to euro pretensions to be the largest reserve currency,” Ruskin said. “It puts a ceiling on how large a share the euro can gain as a reserve currency.”

Australia’s net debt will peak at 6.1 percent, less than a 10th of the average expected for major advanced economies, Treasurer Wayne Swan said May 11 while announcing the nation’s budget. Canada’s budget gap will decline from 4.8 percent in 2009 to 1.6 percent in 2011 according to the median forecast of eight economists in a Bloomberg survey.

On April 6, Canada’s dollar was worth more than the U.S. currency for the first time since July 2008. On April 12, Australia’s dollar traded as high as 93.69 U.S. cents, the closest it had been to parity with the U.S. dollar since reaching 94.06 U.S. cents in November. Canada’s currency strengthened to C$1.0212 at 10:45 a.m. in New York from C$1.0243 yesterday. Australia’s dollar bought 87.79 U.S. cents from 87.65 cents.

Introduced in 1999 to replace the currencies of France, Germany, Italy and eight other nations, the euro’s share of global reserves climbed to 27.4 percent at the end of 2009 from 18 percent a decade earlier. The dollar accounted for 62.1 percent of the $4.6 trillion in reserves for which the IMF has data.

‘Manifestly Inadequate’

The euro’s appeal began to falter in December after EU officials said Greek economic statistics are “manifestly inadequate” in a draft document prepared for the region’s finance ministers. By the end of May, the currency had fallen for six-straight months, the longest slump since its creation.

It traded at a four-year low of $1.1877 on June 7, and 10 days later BNP Paribas SA said it may weaken to 97 U.S. cents by the third quarter of 2011.

“Debasing what has been a strong currency and making it weaker and weaker is in the end going to destroy the euro,” Rogers said in a June 16 interview. It will take 10 to 15 years for the euro to disappear, Rogers said, adding that in the interim he’s bought the currency because pessimism towards Europe has beaten it down too much.

‘Picture of Stability’

Reserve Bank of Australia Governor Glenn Stevens raised the benchmark interest rate six times in the seven meetings through May 4, the most-aggressive series of increases among Group of 20 policy makers. The loonie is appreciating at the fastest rate in two months after the Bank of Canada began raising rates on June 1 with a 0.25 percentage point increase.

“The growth outlook is stronger in these places, the fiscal outlook is stronger in these places and they should be safe havens from a diversification standpoint,” said Jens Nordvig, a managing director of currency research in New York at Nomura Holdings Inc. “They’re a clear picture of stability once that risk aversion move is out of the way.”

EU gross domestic product is forecast to grow 1.4 percent in 2011, according to the median forecast of 18 economists in a Bloomberg survey, Australia’s central bank raised its growth forecast for 2011 in May to 3.75 percent from 3.5 percent three months earlier. The Canadian economy will grow 3 percent in 2011, according to the median prediction of 14 economists in a separate Bloomberg survey.

Smaller Markets

The downside for central banks is that the Australian and Canadian bond markets aren’t as big or liquid as those in Europe or the U.S.

“I don’t think they’ll become major currencies used for global trade or that they can be part of the core of the international monetary system because they are too small,” the ECB’s Noyer said in the interview.

The C$380 billion ($371 billion) Canadian government debt market is less than one-tenth the size of the U.S.’s $5.7 trillion in notes and bonds, while Australia’s A$137 billion ($120 billion) outstanding is about one-third the size of Canada’s.

“There’s not enough liquidity and not enough bonds out there so they could never become a core part of a central bank’s holding,” said Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York.

Sweden’s Riksbank

That hasn’t stopped some central banks from adding the currencies. Sweden’s Riksbank currently invests 5 percent of its 328 billion kronor ($42 billion) reserves in the Aussie and the loonie each, to supplement its 50 percent allocation to the euro and 20 percent in the greenback, said Ann Falken, head of the central bank’s investment division. The central bank is not allowed to speculate on the exchange rates themselves, Falken said in a June 16 interview from Stockholm.

Russia’s central bank has added the Canadian dollar to its reserve portfolio and may add the Australian currency, according to Ulyukayev.

“Adding the Australian dollar is being discussed,” he said. “There are pros and cons. We have added the Canadian dollar but haven’t yet begun operations” in the currency, Ulyukayev said.

U.S. dollars account for 47 percent of Russia’s reserves, while euros make up 41 percent, British pounds 10 percent and Japanese yen 2 percent, Ulyukyaev said in November. The central bank has reduced dollars from 50 percent in 2006, when euros accounted for 40 percent and the remaining 10 percent was in yen and pounds. Russia’s international reserves, the world’s third biggest, reached $458.2 billion on June 4.

‘Liquid Enough’

If central bankers were to determine that the commodity currencies were “liquid enough” to add to reserves, that could lead to “a substantial rise in underlying demand for the Aussie dollar and Canadian,” said Sean Callow, a currency strategist at Westpac Banking, during a June 16 interview from Sydney on Bloomberg Television’s “Global Connection.”

The Washington-based IMF will review the current basket of currencies of Special Drawing Rights, or SDRs, at the end of the year, a process that occurs every five years. There’s at least a 50 percent chance that the Australian and Canadian dollars will be added, said Mansoor Mohi-uddin, global head of currency strategy at UBS in Singapore.

“Because they will become more prominent over time, the IMF may decide the composition of SDRs has become too narrow and these two would be the best new currencies to add to the basket,” Mohi-uddin said. “It doesn’t matter what the proportion is or even if it was a small proportion. It will increase their status further.”

By Oliver Biggadike and Mary Childs

--With assistance by Mark Deen in Paris, Johan Carlstrom and Kim McLaughlin in Stockholm, Paul Abelsky and Maria Levitov in Moscow, Candice Zachariahs in Sydney and Chris Fournier in Montreal and Lukanyo Mnyanda in London. Editors: Robert Burgess, Dave Liedtka

Source >  Bloomberg | June 22