THE current 'difficult environment' poses challenges for managers of foreign exchange reserves across the world, said Dr Tony Tan, the deputy chairman of the Government of Singapore Investment Corp (GIC), yesterday.

Given greater uncertainty and volatility in the financial markets, 'managing foreign exchange reserves to secure a satisfactory return within acceptable risk limits is likely to become more challenging in the coming years as compared with the past decade', said Dr Tan.

He was speaking during a panel discussion yesterday afternoon at the first annual Lujiazui Forum in Shanghai.

The international finance forum brought together financial leaders, scholars and government officials including Chinese Vice-Premier Wang Qishan to discuss financial reform in China.

In his speech, Dr Tan warned that 'economic risks could rise further in the next 12 months because of sharper-than-expected falls in house prices and a further spike in energy costs'.

He added that the sharp drop in United States house prices could deepen mortgage-related losses and dampen consumer spending. Meanwhile, rising energy costs might offset the positive impact of the tax rebates that Americans will get from a fiscal stimulus package.

Mr Tan also raised some difficult issues that managers of global foreign reserves are trying to address. These include the debate over whether the US economy will sink into a deep recession - and if this is likely to spread to major economies.

He also highlighted the question of whether financial risks will abate over the next few years, as well as the thorny issue of inflation plaguing economies worldwide.

If countries were to wager on a world of 'significantly higher inflation and lower growth in the next three to five years', they would then have to solve the puzzle of how to adjust the asset allocation for their reserves to reflect this new outlook.

'There are no clear answers to these questions,' declared Dr Tan.

He noted that in the current 'difficult environment', the growth of major economies outside the US, especially China and India, has become 'even more important in sustaining global growth prospects'.

Capital flows from major Asian and Middle Eastern economies have also become more important in stabilising the global financial system, added Dr Tan.

Fund flows from these countries have helped to prevent 'a disorderly fall in the US dollar' and also helped to 'recapitalise US and European financial institutions.'

This article was first published in The Straits Times on May 10, 2008.