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China last week cut the weighting of the US dollar in a basket of foreign currencies used to determine the strength of the yuan. Photo: Reuters
EconomyChina Economy

China pledges ‘prudence’ in diversifying its foreign exchange reserves in 2020 as global risks rise

  • China will carefully push ahead with diversification of its US$3.1 trillion foreign exchange reserve holdings, says the State Administration of Foreign Exchange
  • The regulator says it will improve its management of reserves ‘with Chinese characteristics’, but has not elaborated on what that means
China economy
Karen Yeung
Karen Yeung
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China will “steadily and prudently” diversify its US$3.1 trillion foreign exchange reserve holdings, the government agency managing the assets pledged in its 2020 work plan, suggesting a subtle policy change in the way Beijing uses its hard currency holdings.

The careful approach would “promote the diversified use ... and ensure the safety, flow, and preservation and appreciation of foreign exchange reserve assets,” China’s State Administration of Foreign Exchange (SAFE) said in a statement published on Sunday, which summarised the results of its annual work conference last week.

It is the first time that SAFE, headed by Pan Gongsheng, deputy governor of the People’s Bank of China, has called for “prudence” in diversifying China’s reserve assets in its annual work conference statement. The regulator also vowed to improve its management of reserves “with Chinese characteristics”, although it did not explain what that meant.

SAFE added it would prevent risks caused by external shocks endangering “national economic and financial security” in 2020.

China’s diversification strategy for its foreign exchange reserves - which generally indicates a reduction in holdings of US government bonds for other riskier assets - has gained speed in the past decade after the creation of a separate sovereign wealth fund in 2007. SAFE has created a special office of lending dollars to institutions like the China Development Bank to finance overseas projects and launched a number of overseas offices for investment.

In its 2018 annual report, SAFE revealed for the first time the share of US dollar denominated assets in its reserves portfolio for the period 2005 to 2014. Dollar assets accounted for 58 per cent of China’s total reserves by 2014 - the most recent data provided - down from 79 per cent in 2005, the report showed.

By international standards, the share of US dollar assets in China’s reserves in 2014 was below average. The latest data from the International Monetary Fund showed that 61.8 per cent of the world’s reserves assets were denominated in US dollars at the end of the third quarter last year.

Japan surpassed China in June as the largest foreign holder of US Treasury securities, with Beijing’s holding of US Treasuries - the most liquid and safe financial assets in the world - having fallen for four straight months to US$1.1016 trillion at the end of October.

Tommy Xie Dongming, an economist at OCBC Bank in Singapore, said it makes sense for China to reduce its US Treasury holdings and diversify into other foreign currency assets to have a more balanced portfolio. China has evolved in recent years from a passive investor in safe but low yielding assets into an active investor buying slightly riskier investments with higher returns, he said.

China’s central bank last week revised the weighting of a basket currencies used in calculating the yuan exchange rate by cutting the US dollar weighting slightly to 21.59 per cent from 22.40 per cent.

The China Foreign Exchange Trade System, a unit of the Chinese central bank, said the change reflected the current state of bilateral trade as the US accounted for only about a fifth of China’s total trade volume, even though at least two thirds of the country’s international trade payments are settled in US dollars.

Ken Cheung Kin-tai, chief Asian FX strategist at Mizuho Bank, said the adjustment partly reflects the central bank’s intent to scale back the US dollar’s influence over the yuan’s value.

China has maintained a foreign exchange stock pile of about US$3.1 trillion in recent years, down from a peak of nearly US$4 trillion in the middle of 2014, thanks to draconian capital controls on Chinese individuals and corporations.

At the same time, SAFE said it would continue to use its foreign exchange reserves to help projects under Beijing’s Belt and Road Initiative.

This article appeared in the South China Morning Post print edition as: Beijing stresses prudence with forex assets as risks rise
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