China optimizes foreign exchange reserve structure

Economists and policy advisers have said that it is a strategic necessity for China to further scale back holdings in United States government debt in order to safeguard national financial stability, amid waning confidence in the dollar-based system and persistent geopolitical tensions.

To pursue a more balanced, controllable allocation of foreign exchange reserves, the country is also likely to increase investments in non-dollar assets, including financial instruments of its Asian trading partners and crucial resources such as gold, energy and food, they added.

Yu Yongding, an academic member of the Chinese Academy of Social Sciences, called for China to continue reducing US government debt holdings in an orderly manner.

"The ideal approach would be to increase imports and utilize the excess foreign exchange reserves to purchase high-tech capital goods and strategic materials. This could require China to narrow its trade surplus, move toward a basic balance in the trade of goods and services, or even run a trade deficit for a while."

"Extraordinary times call for extraordinary measures. We must closely monitor the US fiscal situation and prepare contingency plans to avoid being caught off guard," Yu said.

After stepping back from being the second-largest holder of US debt to third place in March, China further reduced its holdings of US Treasury securities in May by $900 million, to $756.3 billion, the lowest since February 2009, when the reading was $744.2 billion, according to the US Department of the Treasury.

The reduction bucked the overall rebound of foreign holdings in US debt after a drop in April. Foreign holdings of US Treasury securities increased from April's $9.013 trillion to $9.046 trillion in May, with major US debt holders such as Japan, the United Kingdom and Canada increasing their holdings.

Wang Peng, an associate researcher at the Beijing Academy of Social Sciences, said that China's holding cut in May — the third consecutive month of decrease despite other major holders' increased exposure — stems from a continued effort to optimize the structure of foreign exchange reserves.

The aim is to reduce the risks of overreliance on US government debt and limit potential economic losses from geopolitical tensions, including the risk of asset freezes in the event of US sanctions, Wang said, adding that the move also reflects concerns about growing US fiscal deficits and uncertainty about the US economy.

Pan Gongsheng, governor of the People's Bank of China, the nation's central bank, has pointed to the risks associated with the US dollar's dominance as the global reserve currency, saying last month that US fiscal and financial regulatory problems could spill over, while the dollar could be weaponized in geopolitical conflicts.

Guan Tao, global chief economist at investment bank BOCI China, said there is no immediate risk of a US sovereign debt crisis, as market demand for US Treasuries remains strong, and US Treasury yields could fall if the US Federal Reserve cuts rates later this year. Bond yields move in the opposite direction of prices.

But the deeper concern, Guan said, is US debt's long-term sustainability. If US government debt keeps expanding without a path to stabilization, it will eventually trigger problems.

Credit ratings agency Moody's downgraded the US credit rating to Aa1 in May, citing runaway deficits, while the US administration's massive tax-and-spending bill, effective this month, could intensify such concerns, as it is forecast to increase US federal deficits by more than $3 trillion over the next decade.

Chen Weidong, director of the Research Institute of Bank of China, said, "As the third-largest holder of US Treasuries, China must build a multilayered, systematic strategy to guard against mounting risks tied to US sovereign debt and the dollar-based financial system.

"This is not only vital for China's financial security, but also has far-reaching implications for the evolution of the global financial order," Chen said, adding that China has cut its US Treasury holdings by over 40 percent since 2013.

He said that key priorities for China going forward include gradually reducing US Treasury holdings, optimizing the dollar investment portfolio by allocating more to short-term securities, increasing non-dollar investments, and advancing renminbi internationalization.

He also called for deepening financial cooperation within Asia — which together holds over 60 percent of global reserves in dollar-denominated assets — so that Asia can form an internal reserve circulation system and reduce its reliance on external markets.

China has been stepping up efforts to diversify its reserve assets. The country's official gold reserves rose for the eighth consecutive month to 73.9 million ounces at the end of June, the State Administration of Foreign Exchange said.

The country's foreign exchange reserves, meanwhile, increased to $3.32 trillion as of the end of June, marking the highest level in nearly a decade, the administration said.

zhoulanxv@chinadaily.com.cn