China to diversify FX reserves

A lot of interest in this over the last few days. Someone sent me a UBS report which contains the following. I'm sure US banks and hedge funds are queuing up for a chance to manage some of these funds. Will we see Chinese FX reserves recycled into equities and other less liquid assets?

China’s inter-agency Financial Work Conference ended over the weekend, and we’ve started to see gradual information flow about the results. This was a rare occasion for the senior leadership to meet and decide on the direction of financial sector policies for the next few years to come.

The main issues included restructuring of state bank management, new bond market regulations, creation of a deposit insurance scheme, fostering rural finance – and, of course, potential changes in FX reserve management and portfolio allocation. With regard to the latter, we do expect to see changes ahead, but we don’t see any near-term implications whatsoever for US or other overseas asset markets.

Going into the conference, the issue of management and allocation of China’s US$1 trillion of FX reserves was clearly one of the biggest policy issues on the table. Needless to say, popular proposals over the past few months have run a wide gamut, including diversification of the PBC’s own portfolio, transferring reserves to the existing Central Huijin Investment Company, allocating reserves to a new State Investment Corporation, creation of a new energy-related private equity vehicle, recapitalizing the National Pension Fund, etc.

At the conclusion of the meetings, it is clear that policymakers did agree on some form of restructuring – however, it is also clear that there has been no detailed decision as to what form that restructuring might take. Premier Wen Jiabao announced that China will “actively explore and broaden the channels and manner of using its foreign exchange reserves”, but that is the only statement we have from the senior authorities on the topic. While we could see further announcements over the next few quarters, as we argued in last week’s note (Big News on Chinese Reserves?, UBS Asian Economics, January 18), we don’t see any significant near-term implications for the US dollar or US treasury market.