MercoPress. South Atlantic News Agency

China diversifying forex reserves to Asian currencies (South Korea and Japan)

But Chinese demand makes currencies stronger and hurts exports

China is increasingly looking to its Asian neighbours' currencies to lessen its reliance on the US dollar, both for investment and trade. Slowing the pace at which it amasses US Treasury papers, China has started buying more South Korean and Japanese government bonds.

While the volumes involved are small compared to its holdings of US debt, the moves are helping to illuminate Beijing's strategy to diversify its vast foreign-exchange reserves and shows that it is willing to let smaller markets play a bigger role in its holdings.

This week China added the Malaysian ringgit to a small group of currencies it allows to be traded directly against the Yuan, a small but central part of its plan to increasingly use the Yuan to settle trades throughout Asia.

The ringgit soared to a near 13-year high against the dollar, propelled by the news.

China, the largest holder of US debt, has been promising to move its foreign-exchange reserve holdings away from US dollars since the start of the financial crisis, but it has moved slowly to avoid roiling markets and putting undue pressure on the US dollar and on the value of its own US dollar-denominated assets.

However, the sheer size of the reserves and the relative secrecy in which the foreign-exchange regulator operates has made financial markets sensitive to any sign of a change in China's forex reserves.

The State Administration of Foreign Exchange, the branch of China's central bank responsible for managing foreign-exchange reserves, has about 2.45 trillion US dollars of foreign-currency assets in its coffers, the largest of any country in the world. But little is known about how they are allocated.

Earlier this week SAFE disclosed that it accumulated 81.1 billion USD of new forex reserves in the second quarter, excluding the effect of exchange-rate changes.

South Korea and Japan paint a somewhat more illuminating picture of Chinese diversification, though the amounts involved are small relative to China's total holdings.

South Korea's Financial Supervisory Service shows that the total holdings of all Chinese institutions in Seoul's treasury more than doubled to 4.3537 trillion Korean won (4.15 billion USD) at the end of July from 1.8724 trillion won at the end of 2009.

Data from Japan's Ministry of Finance show that China bought a net 1.73 trillion yen (22.7 billion) of Japanese government bonds in the first half of this year, compared with a net sell off of 5.9 billion yen a year earlier.

That strong demand has been a key factor strengthening the yen in recent weeks, to the frustration of Japanese exporters.