Japan should sell 80 percent of FX reverses to cut risk

TOKYO (Reuters) - Japan should steadily sell off 80 percent of its foreign reserves rather than set up a sovereign wealth fund to actively manage this money, said a former government official who advised then-Prime Minister Junichiro Koizumi on economic policy.

Mitsuru Taniuchi, now a professor at Waseda University in Tokyo, said there was a growing risk of valuation losses due to currency moves because Japan's reserves are now the world's second-largest behind China at more than $1 trillion.

"It would be appropriate to gradually sell them, possibly over several years, while monitoring the market," the former director-general of the Cabinet Office's research bureau told Reuters in an interview.

"If we sold $800 billion quickly, it would of course disrupt the market."

Taniuchi said setting up a new investment body to more aggressively manage the international reserves was not the way to go despite calls from some ruling party lawmakers for the government to create such a sovereign wealth fund.

"It is not a job for the government. As Koizumi has said, what the private sector can do should be left to the private sector. That is the key concept for Japan's economy," he said.

Although China and Singapore have set up investment funds to more aggressively manage part of their foreign reserves, Japan should not simply follow suit, Taniuchi said.

China regulates capital flows and its controlled yuan market means Beijing cannot just sell foreign assets in the reserves without affecting the currency markets heavily, while similar sales would influence price levels greatly in Singapore as it is a small and open economy, he added.

But Japan has the option of trimming its reserves by selling foreign assets, Taniuchi said.

If Tokyo were to do that, the Ministry of Finance, which manages the reserves, should say so in advance so that it could avoid surprising the markets and instead create the view that the sales were aimed at trimming currency risk but not at guiding the yen higher, he added.

Taniuchi said that although Japan missed a golden opportunity to sell dollar assets in the reserves when the dollar was stable near 120 yen until the middle of last year, it is still a valid approach.

After the dollar fell to a 13-year low below 96 yen as the U.S. credit mess deepened, Finance Minister Fukushiro Nukaga said in late March that unrealized losses on Japan's foreign reserves amounted to about 18.5 trillion yen ($177 billion) when the dollar was around 100 yen.

The dollar was hovering near 105.40 yen on Wednesday.

Taniuchi said that although such losses would not be realized as long as the ministry holds the foreign assets in the reserves, the government should take responsibility and try to minimize potential losses arising from foreign exchange risks.

Judging by the international reserves held by other industrial nations, Japan could sell about 80 percent of its reserves and still have more compared with its GDP and currency market scale than other major economies, he added.

Japan's reserves ballooned after yen-selling intervention worth a record 20 trillion yen ($191 billion) in 2003 and a further 15 trillion yen in the first three months of 2004, as the government waged a campaign to prevent a rapid rise in the yen from derailing Japan's then-fragile economic recovery.

Tokyo has stayed out of the market since then.

Taniuchi said several academic studies found that currency intervention in industrialized economies had a limited impact on the currency market.

So selling foreign assets in the reserves would not roil the market as long as it was done over a number of years, which the United States would also understand, he added.

The currency breakdown of Japan's external reserves is not disclosed, but historical data on the nation's currency intervention suggests that most of its reserves are in dollars.

($1=104.70 Yen)

(Editing by Hugh Lawson)