China Accelerates Diversification of Forex Assets

The Obama administration’s economic stimulus plan has got China in a bit of a quandary. On the one hand, China is boundless in its hopes the plan works and as soon as possible, for the rebound of the US economy would be angelic news for China’s exporters. On the other hand, with the US government deficit looking to reach as high as $1.5 trillion, more and more economists and government officials are strongly suggesting China shy away from adding to its already vast holding of US national debt, and maybe relieve itself of some of that holding.

China’s experts see US long-term debt piling up in the not so distant future, and feel it would be wise to sell mid- and long-term debt now. The risk of short-term national debt is comparatively more controllable. China increased its holding of short-term US bonds by $40.4 billion, $56 billion, and $38 billion in September, October and November, respectively. At that time, China began to sell long-term government debt.

And recently China has been working to diversify its forex reserve. Chinalco’s $19.5 billion capital injection into Rio Tinto, so far the largest foreign investment of any Chinese enterprise, is believed to signal China’s holding’s transition into strategic resources. Officials and leaders of state-owned enterprises also suggest the government inject some of the reserve into state-owned enterprises to help them invest overseas or establish funds for overseas acquisition.

China’s investment attempts in overseas financial assets have not been unsuccessful, but they haven’t always had happy results. CIC’s investments in Blackstone and Morgan Stanley have both seen a huge book loss, while Ping An’s investment in Fortis has been all but negated.

China’s forex reserve is now mainly invested in high rated overseas government bonds, international financial institution bonds, and corporate bonds. China has invested in bonds in both Asia and Europe to diversify its holdings.

China has also invested in foreign stock markets. The State Administration of Foreign Exchange is allowed to invest about 5% of China’s forex reserve into products other than bonds. By August, 2008, it had bought stakes under 1% in dozens of British listed companies for several billions of pounds.

Besides multi-currency investment in financial assets, the Chinese government has become lately interested using some of its financial assets to ensure its supply of various commodities, such as petroleum and raw materials.

From a short-term perspective, among all portfolios, US bonds are still the safest. But China has increasingly seen that equity investment and resource investment may well bring better and more profitable returns.

China has also begun to increase its investment in US assets with higher risk, particularly US stocks.

China is aware that, for now, short-term US national debt still has the highest liquidity on the global financial market, and that the USD’s dominant position will remain unchanged.

China’s continuous purchase of US national debt also has a political side. Long Yongtu, Secretary-General of Boao Forum for Asia, says China will continue to buy US national debt with some of the trade surplus gained from Sino-US trade to balance the trade relation between the two countries.

According to Long, the China-US trade surplus totaled about $260 billion last year, and China invested $160 billion in the US national debt. This is a very important basis for the Sino-US trade relation. Since the current balance is best for both parties, China will continue to buy US national debt.