How are China’s foreign-exchange assets safe when most are held in financial instruments that can be frozen or nullified with the push of a button on an adversary’s computer keyboard?
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China Has ‘Price to Pay’ for Cutting U.S. Dollar Share of Forex Reserves, Analysts Say
By Karen Ueung
South China Morning Post, Hong Kong
Tuesday, July 30, 2019
China’s sharp reduction in U.S. dollar asset holdings has increased the risk of its investment portfolio, analysts have said in response to a disclosure of historical data by the agency charged with managing its foreign exchange reserves.
The State Administration of Foreign Exchange (SAFE) on Sunday disclosed that it had cut the portion of U.S. dollar-denominated assets in its reserves portfolio to 58 percent in 2014, below the international average of 65 percent and down sharply from the 79 percent of China’s holdings in 2005.
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And while Beijing hailed its diversification from U.S. dollar overdependence as a sign of progress, it drew suspicion from private-sector analysts as to whether assets in other currencies, or even gold, could provide the same security and liquidity as US dollar-denominated assets.
Aidan Yao, senior emerging Asia economist at AXA Investment Managers, argued that U.S. assets, particularly U.S. Treasury securities, are “the most liquid and safe assets in the world,” and so cutting their share in the portfolio was, by definition, a risky move.
“China does have to pay a price — compromising liquidity and safety of their portfolio — for diversifying away from the U.S. dollar,” Yao said.
SAFE revealed details of its foreign reserve management only over the decade to 2014. Ding Shuang, chief China economist at Standard Chartered, said it would have been hard for China to cut the weighting of its U.S. dollar assets further after that point, since it was already quite low.
“There is no alternative market that can offer China the ease and safety in trading that is as deep and broad as the US dollar market,” Ding said.
If SAFE maintained the same weighting after 2014, China would have about $1.8 trillion of its reserves in U.S. dollar assets today. U.S. Treasury data showed that China held $1.1 trillion of U.S. Treasury securities as of the end of May.
David Chin, founder of Basis Point Consulting, a financial consultancy based in Sydney, questioned why SAFE did not disclose anything about its foreign exchange reserves management after 2014.
The exact investment composition of China’s foreign exchange reserves remains shrouded in secrecy, making it nearly impossible to see the true risk and performance at the moment, he added.
“The real question to be asked is: Why not give us figures up to 2018 or even 2017? They already have that [data] so that would be a stronger show of increased transparency,” Chin said.
Nevertheless, analysts welcomed SAFE’s disclosures as a step toward greater transparency. Before Sunday little was known about how SAFE managed China’s reserves.
Instead, every January 1 over the last decade China’s central bank chief paid a visit to a drab building within a stone’s throw of the People’s Bank of China’s head office in Beijing.
“In the face of complicated and changing international financial markets, a diversified investment strategy has been implemented for China’s foreign exchange reserves that has achieved steady returns,” the agency said.
The agency reminded readers that it had won two “excellence awards” from Asia Investor in 2014. Asia Investor is a quarterly publication by UK-based publishing group Haymarket Media.
SAFE, an arm of the central bank that reports directly to China’s top leadership, highlighted in its annual report two main strategies used to manage the country’s reserves.
One is “diversification” of assets into multiple currencies, resulting in the sharp decline reliance on U.S. dollar-denominated assets. The other is a rigid risk-control process based on the twin principles of maintaining value while maintaining zero tolerance for major risks.
SAFE said it has five layers of checks for its assets — risk policies, risk assessment and monitoring, compliance inspection, internal auditing, and external auditing — designed to manage all types of risks, including “credit risks, market risks, liquidity risks, operational risks, and other risks.”
China’s foreign exchange reserves ballooned from $51.6 billion at the end of 1994 to a peak of nearly $4 trillion by mid-2014. The reserves dropped by about $1 trillion in the year following China’s stock market rout in the summer of 2015, causing Beijing to impose draconian capital account controls over outbound payments and investments.
While the reserve size was stabilised at about $3 trillion over the past three years, the size is unlikely to grow significantly, as China’s current account surplus is projected to shrink.
At the same time, China’s efforts at making the yuan an international currency have achieved only limited success. The yuan’s share of total reserves held by global central banks remained a modest 1.84 percent in the first quarter of 2019, well below the dollar’s 58.14 per cent, the euro’s 19.03 percent, and the yen’s 4.94 percent.
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