China will keep buying U.S. Treasuries as it diversifies reserves

By Christina Soon
Bloomberg News Service
Sunday, March 11, 2007

http://www.bloomberg.com/apps/news?pid=20601087&sid=a5waLpE3W.zc&refer=home

BEIJING -- China will keep buying U.S. Treasuries after a new state investment agency begins operations to help the nation manage its $1.07 trillion foreign-exchange reserves, central bank Vice Governor Wu Xiaoling said.

China, the second-largest holder of U.S. government debt, wants to invest its reserves to support an economy that grew 10.7 percent last year, without causing large swings in global markets. The dollar slumped 1 percent against the euro in the week ended Nov. 11 after central bank Governor Zhou Xiaochuan said he plans to diversify holdings.

Asked today in Basel, Switzerland, whether China would continue to buy U.S. Treasuries, Wu told Bloomberg News: "Yes." Wu is attending the bi-monthly meeting of central bank governors from the Group of 10 nations.

The People's Bank of China had a 26 billion-yuan ($3.4 billion) loss from exchange rate movements in 2006, according to estimates by Stephen Green, senior economist at Standard Chartered Bank Plc in Shanghai.

The new agency will seek to "maximize the profits" of the reserves, Finance Minister Jin Renqing said March 9. The central bank's Wu on March 8 said "any area is possible as long as it will ensure and increase the return of our investment."

Wu told reporters in Basel that a timeframe for setting up the new reserves agency had yet to be set. "It's still under preparation," Wu said.

China is still studying what the agency will invest in, she said.

Wu said former Vice Finance Minister Lou Jiwei is leading a team in the preparations of the new agency. Lou was on March 6 promoted to deputy secretary general of the State Council, the cabinet.

China is unlikely to diversify "massively" away from U.S. Treasuries to prevent the yuan from strengthening, Jan Lambregts, head of research at Rabobank International in Hong Kong, said in an interview today.

The central bank buys dollars to prevent the value of the Chinese currency from rising from the inflows of export earnings. Diversifying away from U.S. Treasuries would mean selling dollars, Lambregts said.

"They have a policy that they will allow gradual appreciation of the yuan, but no more than that," Lambregts said. "They don't want to see the dollar crash. I continue to see the Chinese as substantial buyers of U.S. Treasuries."

The trade gap swelled 74 percent last year, driving reserves to a record. The surplus and China's foreign-currency holdings have left the economy awash with cash, making it difficult for the government to slow lending and investment to curb asset bubbles.

The yuan has been allowed to gain by as much as 0.3 percent against the dollar either side of a so-called central parity rate since the end of a fixed-exchange rate regime in July 2005.

The central bank calculates a daily rate by taking a weighted average of quotes from commercial banks designated to act as market makers in the currency.

U.S. Treasury Secretary Henry Paulson on March 8 urged China to reduce control over the exchange rate.

Some officials from the U.S. and Europe deem the more than 6 percent yuan appreciation since China dropped a dollar link on July 21, 2005, insufficient to balance the world's lopsided trade. They say the Asian nation deliberately keeps an undervalued currency to benefit Chinese exporters.

China will develop its yuan-denominated corporate bond market this year, Wu told reporters.

"That's part of the broader push to develop domestic financial markets, and a well-functioning bond market is at the heart of such a new financial system," Rabobank's Lambregts said.

The central bank in February ordered lenders to set aside more money as reserves for the fifth time in eight months. Lenders must set aside 10 percent of deposits, up from 9.5 percent.

The central bank has raised its benchmark interest rate twice since April. The current interest rates are "appropriate," Wu said.

The nation is trying to slow investment and lending to curb inflationary pressures and asset bubbles in property and stock markets. The economy expanded 10.7 percent in 2006, the fastest pace in 11 years.

Premier Wen Jiabao on March 5 said China is seeking slower economic growth of 8 percent this year. Ma Kai, director of China's top economic-planning agency, the National Development and Reform Commission, on March 7 said the target is just a guideline.

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