The reserves rose a record $178 billion in the second quarter to $2.132 trillion, the People’s Bank of China said today on its Web site. That dwarfs a $7.7 billion gain in the previous three months.
The World Bank, BNP Paribas SA and Standard Chartered Bank have raised estimates for China’s growth and the Shanghai Composite Index has surged 74 percent this year as record lending and surging investment counter a slump in exports. The increase in the reserves highlights China’s concern that its $763.5 billion of Treasury holdings may fall in value as the U.S. sells record amounts of debt to fund stimulus spending.
“China has the strongest prospects out of all major economies, so it is not surprising that hot money is flowing back,” said Sherman Chan, an economist with Moody’s Economy.com in Sydney. “China has certainly recovered from the downturn, and it is on a strong footing now.”
Economic growth rebounded to 7.8 percent in the second quarter, according to a Bloomberg News survey of economists. That number will be released tomorrow.
The yuan traded at 6.8333 against the dollar as of 10:00 a.m. in Shanghai, from 6.8329 yesterday.
Central bank Governor Zhou Xiaochuan ruled out any sudden change in the management of the reserves last month after proposing that governments investigate setting up a supranational currency.
“It’s inevitable that China will continue investing in Treasuries because of the sheer scale of its reserves,” said Ken Peng, an economist with Citigroup Inc. in Beijing. “Diversification will happen at a slow pace, with commodities the favored alternative.”
Record Lending
This year’s record lending is stoking concern that the nation risks bad loans, asset bubbles and resurgent inflation. The government failed to attract enough bidders at two debt sales last week because of investors’ concern that the central bank will tighten monetary policy.
China’s reserves more than doubled in two and a half years as the trade surplus pumped cash into the economy, fueling claims that the nation’s currency is kept artificially low to help exporters. The International Monetary Fund may describe the yuan as “substantially undervalued” in a pending report, according to a person who has seen the draft.
The reserves are double those of Japan, the country with the second-largest holdings, and account for 29 percent of the global total, according to Bloomberg data before today’s announcement.
Speculative Capital
The bigger gain in China’s reserves was probably driven by higher valuations for non-dollar assets because of the U.S. currency’s weakness, and inflows of speculative capital, or so- called “hot money,” said Dariusz Kowalczyk, chief investment strategist at SJS Markets Ltd. in Hong Kong.
The nation’s trade surplus was smaller in the second quarter than the first and foreign direct investment in China has slowed this year.
About 65 percent of China’s reserves are in dollar assets, with the rest mostly in euros, yen and sterling, estimates Wang Tao, an economist with UBS AG in Beijing. It is “difficult to stop buying U.S. Treasuries when markets for most other assets are too small and too illiquid,” she said in a report last month.
For China to hold 5 percent of its reserves in gold, it would need to buy more than 3,000 tons of the metal, the equivalent of about a year’s global production, Wang said.
Japan should consider diversifying its foreign reserves away from the dollar and buying IMF bonds, the top finance official in the opposition party said.
‘Economic Turbulence’
“In the medium to long term, we need to do what we can to avoid the risk of currency losses or economic turbulence that could result if the dollar were to swing,” Masaharu Nakagawa, the shadow finance minister in the Democratic Party of Japan, said in an interview in Tokyo on July 9.
Demand for U.S. Treasuries is rising on expectations that the world’s biggest economy may recover at a slower pace. The yield on the benchmark 10-year note fell 20 basis points, or 0.2 percentage point, last week to 3.30 percent in New York, according to BGCantor Market Data, as an auction of $19 billion of the securities drew the most demand ever.
China will continue to buy Treasuries because alternatives are too risky or won’t soak up enough money, Kowalczyk said. He also highlighted political opposition around the world to direct Chinese investment, citing miner Rio Tinto Group’s rejection of Aluminum Corp. of China’s proposed $19.5 billion investment. The scrapping of the deal was followed by Chinese allegations that Rio staff stole state secrets.
China Petrochemical Corp. is spending $7 billion to acquire Geneva-based Addax Petroleum Corp. and secure oil reserves in Iraq’s Kurdistan region and West Africa. China’s sovereign wealth fund, meanwhile, has lost money on investments in Blackstone Group LP and Morgan Stanley.
To contact the Bloomberg News staff on this story: Kevin Hamlin in Beijing at khamlin@bloomberg.net; Li Yanping in Beijing at yli16@bloomberg.net
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