NEW YORK - China, the largest foreign holder of US Treasuries, continued to increase its purchases in June as its holdings rose by $5.7 billion to $1.17 trillion, according to new data from the US Department of the Treasury.

China boosted its holdings for the third straight month although global demand for US stocks, bonds and other financial assets weakened in June from a month earlier as the US Congress remained deadlocked over the debt ceiling, which were not settled until Aug 2.

But analysts say that the political infighting over the debt limit talks and the weakening US economy should send a clear signal to China, the biggest creditor to the US, that the only sustainable solution for China is to "move forward with currency/capital account reform", said Yao Wei, China economist with SocieteGenerale, a French bank, in Hong Kong.

"The debt ceiling drama serves as a strong reminder to Chinese policymakers that the current model is not sustainable. China has to rebalance its economy, open up its capital account, and reform its currency regime to meaningfully slow down the pace of foreign exchange reserves accumulation," Yao added.

While many experts say that there is not much China can do in the short term, it should consider diversifying its investments.

"As for diversification, gold probably tops on the list, besides euro-denominated assets and emerging market debt. The share of gold in China's foreign exchange reserves is significantly lower than those with other central banks. The pace of diversification will be subject to the situation in global financial markets and China's own pace of currency reform," said Yao.

Others, however, still believe the US Treasuries are one good option for China because the choices are limited.

"It's not feasible for China to drastically reduce investment in US T-bonds, and definitely not a good idea to withdraw from (buying) the US (bonds), either. China can purchase some Japanese yen, British pounds, or Swiss francs, for example, but the US dollar is still the most trustworthy, and the US remains the safest place to invest," said Zhu Zhiqun, a professor of political science and international relations at Bucknell University in Pennsylvania.

Zhu said that China should, however, be "more creative" and look into diversifying investments in different sectors in the US market and the domestic market.

"Chinese companies can help the failing US businesses through acquisitions and purchases. The US Congress is likely to block Chinese investment in key sectors related to US national security such as the oil industry, but it is not opposed to Chinese investment in less sensitive businesses," Zhu said.

"China should also allocate some of its foreign reserves to invest domestically to stimulate domestic consumption and further growth. In the long term, China has to shift away from the export-driven growth model and expand its domestic market," Zhu said.

The new Treasury data showed that foreign residents decreased their holdings of long-term US securities in June - net sales were $11.5 billion. Net sales by private foreign investors were $23.0 billion, and net purchases by foreign official institutions were $11.5 billion.

Japan, the second-largest holder, reduced its holdings in June by $1.4 billion to $911 billion. Hong Kong, counted separately from China, reduced its holdings by $3.5 billion to $118.4 billion in June.

Monday's report also reflected the concern over the debt limit crisis which affected many investors' confidence in the US economy.

Shortly after Washington reached a last-minute deal on raising the debt ceiling earlier this month, rating agency Standard & Poor's downgraded the US credit rating to "AA+". Other rating agencies such as Moody's kept the US' AAA credit rating but put a "negative outlook" on it for review, which indicates that the rating could be knocked down within six months to a year's time.

Although many believe that the S&P downgrade is largely due to the political standoff over the debt ceiling talks, some experts think Washington's political foot-dragging has done enough damage to the US credibility.

"The damage to US credibility has been done - the process showed an inability to deal with tough problems in a mature and reasonable way. The deal (on the debt ceiling) as constructed will not help the US economy grow but rather jeopardizes the economy," said David Riedel, president of Riedel Research Group in New York.

Zhu, however, said he thinks the US and China are linked economically and are "joined at the hip" and that no dramatic change will be seen in the near future.

"They need each other - the US remains China's largest export market and strong growth in China helps the US recovery. So in the months and years ahead, the two countries will have no other choice but to continue to cooperate on trade and economic issues even if they may continue to disagree on China's currency, trade imbalance, protectionism and others," Zhu said.

China Daily