Developing countries that have amassed large US dollar reserves face a growing threat of big losses from a sudden decline in the dollar, the World Bank warned yesterday.

In its 2005 Global Development Finance Report, the bank identified the "gravest risk" for emerging markets as a deep and disorderly dollar decline. This could create volatility, including a dollar collapse below what the bank's economists see as its long-term equilibrium level.

The result, it said, could be "a costly restructuring of world industry that would have to be undone in following years as the dollar returned to its equilibrium level".

But even in the event of a continued steady decline in the dollar the bank warned that countries with big dollar reserves faced capital losses, continuing the pattern of the past 2½ years.

Foreign reserves held in developing countries rose from $292bn (€227bn) in 2003 to $378bn last year, the bank said in the report. Asia, and particularly China, accounted for much of this, but 101 of 132 developing countries increased their reserves last year.

The report's warning was echoed by the International Monetary Fund, the bank's sister organisation, yesterday. Rodrigo Rato, IMF head, said: "A sharp increase in US interest rates would adversely affect the expansion and lead to a significant deterioration in emerging market financing conditions."

In its report, the World Bank called for a "managed appreciation" of key Asian currencies, to help promote domestic-led growth and a more balanced pattern of global growth.

Although developing-country economic policies have improved, poorer countries face increasing risks from global current account imbalances, the bank said. "A sharp depreciation of the dollar could result in large capital losses in local-currency terms for developing countries with substantial dollar reserves."

Much of the emerging market's growing foreign reserves were invested in US Treasuries, the bank said. Federal policymakers, among others, have identified overseas demand for US assets as one reason holding down long-term interest rates in the US.

If the dollar continues to weaken, exchange rate pegs and enormous build-ups in foreign exchange reserves make it harder for countries to manage their domestic economies, the bank said. Strong global growth last year, driven by the US and China, contributed to the fastest growth in developing countries in three decades.

Last year was a record year for developing countries, with overall growth of 6.6 per cent. But the global economic cycle peaked in the second half of last year, it said. Higher interest rates, in the US, and the stubbornly high oil price would damp growth this year, it predicted, potentially triggering a rise in risk aversion among investors and more difficult conditions for emerging markets.

A managed appreciation of Asian currencies, it said, would complement the US's efforts to rein in its fiscal deficit, and efforts to promote faster growth in Japan and the eurozone. The eurozone, it said, needed looser monetary policy compared with the US as the Federal Reserve continued to raise interest rates.

The Group of Seven leading industrial countries has pressed for greater exchange rate flexibility in Asia, particularly in China, whose currency is pegged to the dollar.