International ties

Wen's Europe tour and China's reserve diversification

By Hua Xiuping (chinadaily.com.cn)
Updated: 2011-06-28 10:53

Chinese Premier Wen Jiabao started a three-country tour of Europe last Friday. It not only helps to foster closer economic ties with those countries, but also signals China's desire to diversify both the currency and asset structures of its foreign exchange reserves.

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As we all know, China has the world's largest foreign exchange holdings, amounting to $2.85 trillion at the end of 2010. The current composition of China's foreign exchange reserves is not revealed, but it is widely recognized that around 60-70 percent of the reserve are dollar assets and most of them are government bonds.

A significant proportion of American debts lowered returns to reserves. Research conducted by Dr. Bin Zhang, Dr. Xun Wang and myself last year reveals that both the nominal and real effective returns would be higher if China had bought more euro assets during 2002-2009. Besides, by holding too many American debts, China faces tremendous insolvency risk of the US government as well.

Figures released by China's official Ministry of Commerce reveals that in 2010 Chinese outbound non-bond investments just reached $57.9 billion dollars. As pointed out by research conducted by the Heritage Foundation in Washington, DC, this phenomenon indicates that China's accumulation of capital continues to far outstrip its ability to creatively and productively redeploy it.

Given the above collection of background information, it is easy to conclude that China shall diversify away from American debts.

Seemingly the Chinese government is trying to take some action now. Just in advance of boarding a flight to Britain, Premier Wen has pledged to buy billions of European government bonds. It will not only contribute to keeping Europe's single currency project alive, but also help to diversify the currency structure of China's huge foreign exchange reserve.

However, asset structure diversification may be much more important. Today China needs to expand non-bond investment overseas, though it faces more challenges or constraints, either politically or economically, than buying debts.

Premier Wen's visit to MG Motor UK Limited in Birmingham last Sunday may send some interesting signals on China's desire to reserve asset diversifications. According to BBC news, from Wen's visit to the MG car plant, some British businessmen sensed a very strong message about the interest China has with doing more business with them.

As a fully Chinese funded subsidiary of Shanghai Automotive, MG Motor UK provides the very model of how China and the UK work together for mutual gain: the MG cars are designed in the UK, made in China and then assembled in the UK, and are generally welcomed warmly and reviewed enthusiastically in both countries.

In the last two decades, struggles to make investments profitable and other challenges have brought a lot of cautions towards China's non-bond investments overseas.

Being an optimist, I advocate 'learning by doing' with my full heart. With respect to China's non-bond investments overseas, I believe, to some extent, problems and risks may have been exaggerated, while benefits and profiting prospects are underestimated.

Just bear in mind, if we never try or stick to a move, how could we know we are always losing or will fail eventually? MG Motor UK is exactly such a typical case. It had suffered big financial losses, but slashed the loss dramatically in 2010. Now analysts are expecting that it will move into profit in 2011.

To conclude, only through non-bond investments overseas are we are able to make global resources, obtain advanced technology, enhance management expertise and efficiency, and upgrade our domestic companies, brands and productivity.

Dr Xiuping Hua, Assistant Professor in Finance, Nottingham University Business School (NUBS), University of Nottingham Ningbo China (UNNC). The views expressed here do not necessarily reflect those of the China Daily Website.