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Downgrade of U.S. credit rating inevitable, China may diversify forex portfolio

08-03-2011 09:07 BJT

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The agreement reached by US lawmakers to raise the debt ceiling may have eased investor concern. But China, the largest foreign holder of US debt, is still faced with the challenge of diversifying a massive foreign exchange portfolio endangered by a weakening dollar.

While the last-minute deal eased the immediate debt crisis in the US, some economists say that a downgrade of the credit rating is inevitable.

"It's almost inevitable now the US is downgraded by Standard & Poor's. They made it clear that they were looking forward for trillions of dollars cut in spending over the next five years. But we didn't get that. So S&P will downgrade, "said Stephen Green, regional head of research in Greater China of Standard Chartered Bank.

Green says that Moody's might hold a downgrade for now as America's debt is seen as sustainable under the current plan. But in three years time the US will be downgraded by rating agencies. As for policymakers in Beijing, experts say they may intend to reduce the holdings of US Treasury bonds and halt future purchases as the dollar will probably continue to weaken. But it's not the right time yet.

Martin Hennecke, associate director from Tyche Group said, "China is only buying treasuries to buy themselves time to develop their own consumer market. They don't want the US to fall over the cliff immediately because it's still a big customer for them. It's not really an investment in treasuries, they wouldn't want to do that if they weren't financing their best customer."

Economists say that a massive sell-off of US bonds would be financial suicide for China as it would drive down the value of its own holdings. And now China have accumulated large amount of foreign exchange reserves through export and foreign direct investment. But it will take time to seek alternative ways to invest these reserves.

Green said, "The challenge is when you have large and increasing numbers of FX reserves, it's very difficult to diversify actively. We believe China now is buying less US debt and buying more Euro-debt. And China is also active in some small Asian debt markets, places like Korea, Japan and Singapore. But the amount is very small."

China's foreign exchange reserves rose by a faster-than-expected 30.3 percent year-on-year by the end of June to reach 3.2 trillion US dollars. The country increased its holdings of US Treasury bonds by 7.3 billion US dollars to 1.16 trillion in May. This is the second straight month it increased its US debt holdings.

Editor:Li Wanran |Source: CNTV.CN

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