Rise of the RMB

A yen for change

China shifts reserves into Japanese government bonds

Disillusioned by the dollar and exasperated with the euro; are China’s foreign exchange custodians now yearning for the yen?

In fact, reserve accumulation in the second quarter was the slowest in 11 years, up by only $7.2 billion. But the country’s foreign exchange reserves hit $2.45 trillion at the end of June, so the debate on what to do with such largesse remains a pressing one. Hints at changes in policy are seized upon as signs that a particular currency or asset class may be about to have its day in the sun.

For much of 2009 Beijing eyed Washington’s ballooning federal deficit with growing alarm, worried about its impact on the country’s dollar holdings. SAFE – which manages the reserves – came under media pressure to do more to diversify away from the dollar, with the euro generally the preferred alternative.

That was 10 months ago, and the consensus has moved on pretty sharply. “When China was mainly holding US Treasury bonds, everyone was saying that we should diversify,” a source close to SAFE told Caixin this month. “Now the euro is falling, everyone is saying that we should not hold so many euros.”

Perhaps SAFE agrees. The news this month is that it has been purchasing Japanese government bonds (JGBs) in record quantities in the first five months of the year. Net purchases soared to Y735.2bn ($8.3billion) in May, with total purchases for the year to date more than twice the previous annual record (for 2005). It is also a striking turnaround on the net sales of JGBs of $0.9 billion in 2009.

Despite the record data, no one is ready to call a more fundamental switch into Japanese government debt on SAFE’s part. The purchases are thought to be concentrated in short-term bills with maturities of less than a year, reports Japan’s Nikkei newspaper. That makes them look like more of a temporary option. More likely, SAFE has responded to the worsening fiscal crisis in Greece in May by getting on the phone to Tokyo, and minimising short-term credit risk.

The question of when and how China might move away from a currency policy dominated by the dollar is not a new one. Beijing first announced plans for such a shift in 2005, and then took a small step towards implementing it in 2007, before returning to a dollar peg in 2008.

Then there was a further announcement that a more market-oriented posture would be adopted, with the renminbi to be managed against a basket of foreign currencies. As yet there hasn’t been much indication of how this will be implemented (it’s not in SAFE’s interests to flag it too boldly, of course).

In the meantime the US dollar remains the mainstay in SAFE’s holdings. China’s reserves are thought to be at least two-thirds dollar-denominated. About $900 billion of that is held in US Treasuries.

However, the Chinese are getting a bit more vocal about how they view credit risk. And newly-created Chinese rating agency Dagong Global Credit this week announced that it had stripped the US of its triple-A status, awarding it instead a AA (with a negative outlook). That rated it below China (which Dagong awarded AA+), but above Japan and Britain (AA-). Dagong awarded only seven triple-A ratings, giving top scores to Australia, Norway and Switzerland among others.

‘’Intrinsically, the reason for the global financial crisis and debt crisis in Europe is that the current international credit rating system does not correctly reveal the debtor’s repayment ability and provides the wrong credit rating information to the world,’’ Dagong’s chairman, Guan Jianzhong was quoted as saying on the company’s website.

The Dagong report gives much greater weight to “wealth-creating capacity” and foreign reserves than Fitch, Standard & Poor’s or Moody’s, says the People’s Daily.


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