Japan Should Create $33 Billion Sovereign Wealth Fund, Ito Says

By Ron Harui and Liza Lin

July 10 (Bloomberg) -- Japan should start a sovereign wealth fund with about $33 billion in assets, using interest earned on its $1 trillion of foreign reserves, said Takatoshi Ito, a member of a government advisory committee.

The fund would invest in higher-yielding assets overseas including equities, Ito said in a Bloomberg Television interview in Singapore. It needs to be set up ``as soon as possible'' to avoid exchange-rate fluctuations that may hurt the nation's reserves, he added.

The value of the $592 billion that Japanese investors, including the government, hold in U.S. Treasuries has been eroded in the past 12 months by the dollar's 12 percent drop against the yen. Ito, a member of Prime Minister Yasuo Fukuda's key economic panel, has scaled back his plan since suggesting a $700 billion fund a year ago because of opposition from the Ministry of Finance.

``My proposal is to take interest income separate from foreign reserves, accumulate it and manage it more actively,'' Ito said. ``The reserves are very exposed to currency and interest-rate risks in the future, so this is not desirable.''

He estimates that the government receives interest payments of about 3.5 trillion yen ($33 billion) a year on the reserves, which are held in highly-liquid assets such as Treasuries.

Japan's foreign reserves are second only to those of China, which set up a sovereign wealth fund to manage $200 billion of its $1.68 trillion of reserves in September. Assets managed by such funds will triple to more than $10 trillion by 2015, International Financial Services London said in March.

Carry Trade

Finance Minister Fukushiro Nukaga said in March the ministry focuses on liquidity and safety in managing the reserves. His ministry has said the money should be used in case Japan needs to intervene in the currency markets.

The finance ministry is ``opposed to doing anything about foreign reserves,'' said Ito, who described the current investment strategy as ``basically a huge carry trade.''

In such trades, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread between the borrowing and lending rate. The risk is that currency market moves erase those profits. The benchmark interest rate is 0.5 percent in Japan, compared with 2 percent in the U.S., 8.25 percent in New Zealand and 12.25 percent in Brazil.

The yen has risen against 12 of the 16 most-active currencies in the past year as deepening credit-market losses prompted investors to cut carry trades. The currency traded at 106.83 per dollar as of 8:30 a.m. in Tokyo from 106.76 late in New York yesterday. It reached 95.76 on March 17, the strongest since Aug. 15, 1996.

To contact the reporter on this story: Ron Harui in Singapore at rharui@bloomberg.net; Liza Lin in Singapore at llin15@bloomberg.net