Calls for China to reduce its reliance on US Treasury bonds, diversify investments

Experts and officials have urged China to reduce its excessive foreign exchange reserves and buy more European government bonds to further diversify its forex investments after Standard & Poor's threaten to cut its outlook on US debt.

The amount of foreign exchange reserves should be restricted to between $800 billion (545 billion euros) to $1.3 trillion, says Tang Shuangning, chairman of China Everbright Group, adding that the current reserve amount is too high.

China should further diversify its foreign exchange holdings, experts say. [Provided to China Daily]

China overtook Japan to be the leading forex reserve country in 2008. Its foreign exchange reserves have increased by $197.4 billion in the first three months of this year to $3.04 trillion by the end of March.

Tang also says that China should further diversify its foreign exchange holdings. He suggested five channels for using the reserves, including replenishing State-owned capital in key sectors and enterprises, purchasing strategic resources, expanding overseas investment, issuing foreign bonds and improving national welfare in areas such as education and health.

Tang's remarks found close parallels in the statements made by central bank governor Zhou Xiaochuan. Zhou had remarked that China's foreign exchange reserves "exceed reasonable requirements" and that the government should upgrade and diversify its foreign exchange management using the excessive reserves.

Actually, China has signaled its willingness to diversify its currency reserves with the euro, the primary alternative to the dollar, which accounts for around two thirds of its holdings.

After investing billions of euros in Portuguese and Greek bonds to diversity its "huge" foreign exchange reserves away from the dollar, China is now considering buying more, says Song Zhe, Chinese ambassador to the European Union.

China is also in talks to invest in Spain, including in the reorganization of troubled Spanish savings banks, the Ministry of Foreign Affairs said earlier in Beijing.

Song, meanwhile, cautions over any restructuring of Greek debt, which could force losses on bondholders including China, saying, "We hope governments can ensure the security of our investments."

"The EU is China's most important business partner," says Song, adding that Beijing has an interest in "the stability of the European economy and an early recovery from the crisis" as he reiterated his country's support for the euro.

Outlining how China had already bought several billions of euros of Greek and Portuguese government debt, Song says, "This is still in the beginning phase. In the next step, it's possible we will purchase more."

"In the past, our portfolio was dominated by US Treasury bonds," says Song. "The purpose (of diversifying) is to protect the safety of our foreign exchange reserves."

Song's remarks come close on the heels of ratings agency Standard & Poor's cutting its outlook on US credit to "negative" from "stable. The agency, however, maintained its top rating of "AAA" on US government saying that there was a one-in-three chance that it would lower the rating in two years.

Equities quickly dropped, but the dollar did not weaken and US Treasury interest rates did not rise.

US Treasury bonds reflect the US government's credit and have been a key investment item for the world.

China remained the largest buyer of US Treasury bonds in February, after the country cut its holdings for four consecutive months to $1.15 trillion, according to the latest data from the US Treasury Department.

After S&P's negative assessment on US credit, China's Foreign Ministry urged the US administration to adopt "responsible policies and measures" to protect the interests of investors.

But Chinese experts say that it would be hard to end the leading role of the US. Treasury Bonds as a key investment channel for a country that has more than $3 trillion of forex reserves.

Zhang Ming, deputy director of the Institute of World Economics and Politics under the Chinese Academy of Social Sciences, told Xinhua news agency that it would be hard to find another capital market with such a huge capacity to replace US government debt, since China has $3 trillion of forex reserve assets.