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China to diversify foreign exchange reserves
(China Business Weekly)
Updated: 2004-05-08 09:12
China is looking to diversify its foreign exchange reserves out of US
dollars, according to its top foreign exchange manager.
China's chief forex regulator, Guo Shuqing, said in a recent Financial Times
interview the make-up of the country's US$440-billion forex cash pile was being
altered to include more European and Asian bonds, given concerns over a weaker
US dollar.
The mere thought of China offloading some of its vast US Treasury holdings is
enough to send shivers down investors' spines, risking a further deterioration
in the already-bloated US current account deficit and more dollar weakness.
But, analysts are advising them not to panic.
"It is easy to get carried away with how much they are diversifying.
Certainly they are, but we are talking about a very conservative central bank,
and they will only be doing it very gradually," said James Malcolm, foreign
exchange strategist at JP Morgan in Singapore.
"If you look at the accumulation of reserves, some of that will be going into
euros, but a lot will be staying in dollars. There is talk of more bailouts of
State banks later this year, and that would argue for a build-up of dollars."
Others put Guo's comments in the context of a long-running process of China
seeking a broader mix for its currency reserves.
"They have been shifting in this direction for some time," said Mary Davis,
currency strategist at CSFB in London.
"Aggregate IMF (International Monetary Fund) data from 2002 showed a clear
shift out of dollars into euro- and sterling-denominated instruments. They are
doing this on an ongoing basis, and only an abrupt change would have major
implications."
Analysts agree a shift in the currency regime to link the yuan to a
trade-weighted basket of currencies, rather than a simple dollar peg, would have
little impact on the management of China's forex reserves.
In earlier comments, Guo said China wanted to move to a floating system that
would link the yuan to a basket of currencies. He did not give a timetable for
the switch.
A basket would include at least the euro and yen, in addition to the US
dollar, and up to seven other currencies, including those of China's main Asian
trading partners.
Analysts have stressed this would not necessitate a change in the composition
of reserves to reflect currency weightings in the basket.
"There is a strong incentive for the central bank to hold some forex reserves
in the most liquid currency, as they want to be able to react quickly in the
forex markets if necessary," analysts at Goldman Sachs wrote in a research paper
earlier this year.
That means Chinese authorities are likely to maintain a large portion of
their reserves in the world's most liquid currency, the US dollar.
The choice of a particular basket in the forex regime should not have any
influence on the allocation of excess reserves, suggest Goldman Sachs' analysts.
A shift to a more flexible system would help release some of the upward
pressure on the yuan.
That, in turn, would give Asian countries more scope to allow their own
currencies to strengthen. They have been intervening in their own currencies to
contain gains against the falling US dollar to maintain trade competitiveness in
relation to China.
In that respect, Asia could be where the biggest
currency moves are seen after a Chinese forex system shift.
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